Cash Value Life Insurance: What is it and How Can I Use it?
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What is Cash Value Life Insurance?
Regarding life insurance, specific policies accumulate something called cash value. A cash value is the investment feature of your policy where a portion of your policy earns interest and can be borrowed against in the future. Cash value life insurance policies are permanent, so they tend to have higher premium rates because of this savings component. Cash value life insurance policies all have a fixed premium payment schedule. A specific portion of your premium payment would go towards the actual cost of insurance while the other is deposited into the cash value account. This cash value account earns a predetermined rate of interest on your money of which taxes are deferred. This allows the policyholder to build the cash value of their life insurance policy over time. As the value increases on the policy, the company’s risk decreases due to the fact that the cash value balances out the insurer’s liability.
Types of Policies that Build Cash Value
There are a number of types of life insurance that build cash value over time. They have in common that they are a type of permanent, or whole life insurance policy. However, each policy type accrues cash value differently but all can be accessed through a loan, withdrawal, or if you surrender your life insurance policy. There are many different types of policies that build cash value.
Whole Life Insurance
Traditional Insurance, also known as whole life insurance, is a type of insurance that provides a death benefit for the life of the insured so long as the premiums are paid. While the premiums are paid, the policy will stay in force so your beneficiaries will receive a death benefit when you pass. Like the other insurance policy types on this list, whole life insurance builds cash value over time from your premium payments. In fact, you can submit more than the agreed-upon amount in order to build cash value faster. These are called paid-up additions which can be thought of as small pieces of whole life insurance purchased with dividends. For life insurance purposes, dividends are considered a return of a portion of the premiums you paid for on your policy.
Guaranteed Issue (GI) Life Insurance
Guaranteed Issue Life Insurance policies are similar to the above whole life insurance policies with the exception that there are no health qualifications. As the name implies, you can get accepted for life insurance, guaranteed. The “catch” with this type of policy is that it does not pay out a death benefit to your beneficiaries should you pass away within the first 2-3 years that the policy is in force. This waiting period is common amongst these policies since it is popular with people with serious illnesses or pre existing conditions. While these types of life insurance is available to everyone, the death benefit is generally a lot smaller and the cash value aspect does not build up as much.
Indexed Universal and Standard Universal Life Insurance
The most common of the cash value life insurance policies indexed universal life (IUL)insurance is incredibly flexible and has a greater building potential. Like with other whole life policies, you can reap the benefits of your policy so long as you keep up with your premium payments. Unlike standard whole life insurance, however, this type of policy gives you the benefit of market gains while building cash value. The cash value life insurance benefits from being tax-free with little risk during economic and market downturns. A portion of that interest income made is added to the policyholder’s cash value.
Guaranteed Universal Life
When looking for an option that is lower in cost than standard permanent life insurance but with the benefits of an IUL, you can look into getting a Guaranteed Universal Life policy. This type of cash value life insurance policy has a fixed premium with a much smaller cash value benefit. This version is not as flexible as other index universal life insurance policies but is far more cost-effective for most people. Guaranteed universal life insurance policies have an “end date” similar to term life insurance except that the end date is due to advanced age such as being 100 or older. This simple life insurance policy will grant you a small cash value while being simplistic and easy to get. Typically, there are not any additional riders you add to your policy making it far less customizable.
Variable Life Insurance
Like the others, variable life insurance policies are whole life insurance policies but with an investment component. Similar to an IUL, this cash value life insurance option allows you to trust in the market for a great investment. Variable life insurance policies are different in that they are considered more volatile and have a high-risk, high-reward system. The cash value is invested in assets like mutual funds and can see rises and falls in value. Your account’s value is entirely dependent on how much your premiums are, the fees you pay, and the performance of your investments. Your investments have tax advantages so you can withdraw from the accounts late and receive a tax free income.
How Cash Value Life Insurance Builds Overtime
When you make your monthly or annual premium payment on a cash value life insurance policy, your payments are divvied up. One portion goes towards the death benefit, the amount that your beneficiaries will receive upon your passing. Another part of your premium goes towards the insurance company’s costs and profits. The final portion of the premium goes toward your policy’s cash value. Generally, it takes several years to begin to accumulate any significant cash within the cash value savings. You will not see money in the account right away but once you do you can use the funds for numerous things.
As you get older, the cash value growth may slow as the initial premium payments fund the cash value savings account while the later payments go towards your actual policy. Be mindful that this can differ depending on the policy type that you have and if you pay more in your premiums to add more to your cash value life insurance. Most insurance agencies will be able to give you a prediction of what your cash value accumulation will look like over the course of your policy. Below is a chart provided by Investopedia that details how cash value accumulates over time. The chart below provides an example of a whole life cash value accumulation over a period of 55 years.
| Policy Year | Age | Annual Premiums | Cash Value |
|---|---|---|---|
|
5 |
40 |
$1,178 |
$3,738 |
|
20 |
55 |
$1,178 |
$33,838 |
|
35 |
70 |
$1,178 |
$99,839 |
|
55 |
90 |
$1,178 |
$289,301 |
What Can I Do With My Life Insurance Cash Value?
Pay Premiums
Should you build up enough money within your cash value life insurance policy you can use that cash to cover future premium payments. This can help you reduce your out-of-pocket expenses just be mindful of the fact that while you are saving money in the short term you may impact the amount of your death benefit. This is a good way to provide short-term relief, however, if you are facing a tight financial situation.
Borrow Against the Cash Policy
You can use the cash value that has accumulated to take out a loan against your cash value life insurance. This amount needs to be paid back and will gather interest until the amount is paid back in full. If you pass away before you can pay the loan back in full, the insurance company will take the amount owed from whatever death benefit you have. If you cannot pay back the loan taken out on your life insurance policy, fear not as it does not show up on a credit report. So if you are in your 60s and take out a loan it will not make an impact on anything except how much your beneficiaries will get upon your passing.
Withdraw Funds
Similarly to taking out a loan, the cash value of your cash value life insurance policy can be withdrawn against your death benefit amount. If the cash value had been invested, then the withdrawn amount included investment gains and will therefore be taxable.
Surrender Your Policy for Cash
Similar to withdrawing funds, you can end your cash value life insurance policy by withdrawing the amount of your cash value. This will cancel all coverage you had on your life insurance and your beneficiaries will not get a death benefit upon your passing. This is a better alternative to just ending a policy or letting it lapse. While the insurance company will take out fees and any remaining premiums owed, getting some of your money back is better than none at all.
Pros and Cons of Cash Value Life Insurance
Pros
- Cash Value Life Insurance is Permanent Life Insurance
If your policy can build cash value, it is a whole life insurance policy. That means it will remain in effect until you die and your loved ones will receive a death benefit. This is better than a term life insurance policy because your beneficiaries are guaranteed pay-out without having to worry if it is within that 10-30-year term.
- Tax Advantages with Cash Value Life Insurance
Like other life insurance policies, your beneficiaries will receive their death benefit tax-free so they do not have to worry about not getting the full amount owed. However, the biggest tax advantage of a cash value life insurance policy is that total cash value accumulation is tax-deferred. As your cash value grows, the IRS will not touch it.
- Cash Value Policies Can Have Dividends
However, the biggest tax advantage of a cash value life insurance policy is that total cash value accumulation is tax-deferred. As your cash value grows, the IRS will not touch it.
Cons
- More Expensive than Term Policies
Cash value insurance policies are all permanent policies and they are generally more expensive than term life insurance policies. A term policy may make more sense for you depending on why you want or need life insurance. Term life insurance is ideal for people who need coverage for only a set amount of time to protect dependents in the event of death.
- Takes Time to Grow
Cash value life insurance policies often take a while to see any substantial growth. Depending on the policy, it could take several years before you see anything worthwhile, making a better option for young policyholders. There are, however, life insurance policies designed for a faster cash value growth.
- Not Extended to Beneficiaries
Cash value often reverts back to the insurance company. So any unused cash value built up will not be given to your beneficiaries. You can speak with an agent to see if there are any cash value life insurance policies that do have that feature.
Is Cash Value Life Insurance a Good Choice for Me?
Finding the best insurance for you can be complicated, especially if you are trying to figure out what you need. Life insurance is a financial safety net for you and your family should the worst happen. While cash value life insurance can be a great choice, speaking to an agent can help you figure out the best plan for you. Final Expense Benefits partners with over 20 carriers with customer satisfaction guaranteed. They offer no medical exam options at much more affordable rates that fit your needs. Some of our highly-rated carriers include:
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