There’s been a lot of talk about cash value life insurance lately, and you’re probably here because you want to get to the bottom of what it really is. Fear no more, as this article will not only answer all of your questions about cash value life insurance, but it will also give you an understanding of whether you should buy it or not.
A cash value life insurance policy is a type of life insurance policy that allows you to build your savings over time by owning the policy itself. To be precise, cash value represents the part of your policy that earns interest and that serves you as a safety net in emergencies when you need to withdraw or borrow the money. How much your cash value grows depends on the type of your policy, as well as on the returns that go with it.
If you are thinking about buying the cash value life insurance policy, these are the policies that have this feature:
- Whole life insurance
- Universal life insurance
- Variable universal life insurance
- Indexed universal life insurance
With a cash value life insurance policy, there are a few things to understand. First, your insurance policy provides you coverage for your entire life – it is so-called permanent insurance.
In order to have the life insurance policy, a certain amount of money (a financial obligation) is to be paid regularly – that’s what we call premiums. Depending on the insurance type, the premiums can have a fixed rate (for example, with a whole life insurance policy) or a bit more flexible (for example, with a universal life insurance policy).
The part of your premium goes to your policy fund and is to be paid upon your death. However, the other part of your premium is put on the market by your insurer as an investment – this is your cash value account. Due to deferred taxes on the accumulated earnings, the cash value of your policy is able to grow over time.
This is the most important question you should ask yourself: is buying a cash value life insurance policy actually a good idea? Here are both advantages and disadvantages of owning this kind of policy, which will hopefully help you make a better decision.
- A guaranteed death benefit
No matter how long you get to live, you can feel safe that your beloved ones will receive the death benefit with this kind of insurance.
- Deferred taxes
Cash value insurance allows you to make an investment and not pay the taxes as you would if it were a classic investment. As mentioned before, with every premium you pay, a part of your money goes to your cash value account, which is treated as your personal savings. As long as you keep your earnings in the cash value account, the taxes are deferred on earnings.
- Tax-free benefits to beneficiaries
After you pass away, your beneficiaries are guaranteed a death benefit. What is even better is that they will receive the benefits tax-free, which means they will get the total amount of money. Bear in mind that this might vary in rare cases, depending on your estate. Make sure that you double-check this information with your life insurance company and ensure to receive this advantage of cash value insurance.
- Tax-free loans borrowed against the policy
Cash value brings you a significant dose of security as it serves you as a safety net. Imagine finding yourself in an emergency where you have to withdraw or borrow the money. This usually doesn’t go smoothly and seldom without paying the taxes. With cash value – you can borrow the money against your policy without paying the taxes for this transaction. This comes quite handy in emergencies.
- Premiums paid out of cash value
If you wish to start paying your premiums out of cash value at any moment in time, you are ultimately allowed to. Of course – as long as there are enough funds in your cash value account!
- Easy access to account
A cash value account is the most valuable to policyholders while they are alive. The good thing is that it is pretty easy to access the account and personal savings, and there are many ways to do so – a withdrawal, a borrow, etc. We will cover them all very soon.
- Participating policies
This isn’t the case with all cash value insurance policies, but it is with some – so it makes it a worthy advantage to mention. With a cash life insurance policy, it might happen that the policy owners receive dividends from the insurance company at the end of the year. This can be seen as another form of investment and can be used in various ways – to build up cash value, pay the premiums, or just be taken out as cash.
- Adding Riders for Extra Coverage
Besides a guaranteed death benefit, you are also in a position to add riders for additional life insurance coverage or features. This allows you to access your death benefit money before your death and use it as you find needed. Adding riders is the usual step people with a terminal illness make, as they get a chance to cover medical costs from the insurance money.
- There are criteria to be met
In order to purchase cash value life insurance, there is usually a qualification that determines whether you are eligible for one, and if so – what will the details of your contract look like. The qualification consists of series of medical exams that you have to go through, as your health condition determines the policy you can get. For example, a non-smoker man in his mid-thirties and a smoker in his late fifties will most definitely be offered different options when it comes to life insurance.
- High premiums
Compared to the term life insurance policy, premiums to be paid for cash value insurance are much higher. But you shouldn’t analyze the cost of insurance without checking the other side of the coin. When you take into consideration all of the benefits that you receive, this is understandable. On a further note – if you make the projection of your costs (premiums) and earnings (death benefit and cash value) for both term insurance and permanent life insurance – and compare the results, you will understand that no matter the higher premium payments, you are still profiting more with cash value life insurance.
- Charge for the policy loan
Even though you have easy access to your account and you are available to borrow against your insurance policy, your insurance company will still charge you interest for this transaction. You should bear in mind this information and make sure you understand how high this interest rate would be before signing the contract with the insurance company.
Well, now there has been a lot of talk about different advantages of cash value insurance. We mentioned the vast possibilities of accessing the cash in your cash value account, and now it’s finally time to understand how this can be done.
If you find yourself in a situation that you need the money, you borrow it against your policy. We mentioned already that there is interest to be paid – that is determined either by your insurance company or the state that you live in.
Do I need to repay the loan?
This is the question that we get the most. And the answer is – no. If you pass away without returning the loan, a loan balance – the amount of the money you borrowed – including the interest will be subtracted from the death benefit your beneficiaries will receive.
We’re reminding you once again – taking out a loan against your insurance policy is tax-free.
You are also allowed to withdraw the funds from your account. Bear in mind that this option doesn’t go tax-free if the amount you are withdrawing comes from an investment gain. Again – if you do not return the money you have withdrawn, the amount will be subtracted from the death benefit.
If at any point in time, you decide that you do not need the policy anymore, you can cancel the coverage. The good news is that you won’t walk away empty-handed. On the contrary, you can surrender your policy to the insurance company, and you will receive your cash value (surrender value) minus the surrender charge and/or any unpaid premiums or unreturned loans or withdrawals.
There is even an option to sell your policy for a cash settlement to an investing company. These cases are not that common because – even though they will get you access to your cash value, usually you will get less money than expected. This comes as a result of having a third party arranging the cash settlement and a buying company that wants to get as best deal as possible.
Your cash value is yours to use how you find the most fitting. If it means using it to pay your premiums – that is an option. Depending on the amount of money that you managed to save, you could pay as many premiums as your cash value can cover.
There are a couple of things you should be careful about before buying cash value life insurance. For instance, you should be aware that it would take a couple of years at least (if not decades) to build up cash value with some policies. This could change things for you if you were looking for an easy and fast way to increase your savings component.
Bear in mind also that cash value brings the most value to policyholders when they are still alive. For example, your beneficiaries will receive only the death benefit payout when you pass away – not cash value included. You should check this with the insurance policy as some of them offer an option for beneficiaries to receive the cash value as well – with the higher price of premiums.
Make sure that you sit down with yourself and think about what type of insurance and for what period of time you need. There have been cases of people buying cash value insurance only because the idea of cash value seems appealing, ending the contract with the policy surrender. Probably this won’t happen to you, but just in case – make sure you understand what type of insurance you need, so you know how to use the advantages of it once you buy it.
To help you summarize everything you’ve just read, here’s a list of frequently asked (and answered!) questions. If you have any more – feel free to leave them in the comments!
- Can I build up cash value with a term life insurance policy?
No – term life insurance does not include the cash value component. If you want to purchase a cash value insurance policy, you can choose from these types of life insurance: whole life insurance, universal life insurance, variable universal life insurance, and indexed universal life insurance.
- When is the earliest I can expect to accumulate a cash value that can be used?
This is hard to say because there is no correct answer. One thing is sure – it can take up to decades for cash value to be accumulated, and it depends on the policy that you purchase. A piece of advice is to ask for this information from the insurance agent and calculate in advance how long it would take to build up cash value.
- Is a cash value life insurance policy suitable for people with a high income?
It is one of the best solutions for people with a high income. Remember that the earnings from cash value are tax-deferred, which comes in handy, especially if you have high incomes, as you don’t have to pay the income tax.
If you came to the end of this blog, you should now have a clearer picture of cash value insurance – its pros and cons, price, and everything that comes with it.
There is no doubt – people are purchasing cash value insurance because of its benefits – a guaranteed policy’s death benefit, a tax-deferred investment, a safety net, and easy access to the savings account. It is up to you now to understand whether you need these benefits and how they contribute to you and your loved ones. That’s how you will know what’s the best option. Good luck!