Cash value life insurance provides a cash value feature that you may use while you’re alive. Although a cash value life policy is more expensive than a term life policy, a cash value life insurance allows you to make withdrawals, take out a loan, and increase your death benefit within your policy.
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What Is Cash Value Life Insurance?
Cash value life insurance is a feature of permanent life insurance policies that include both a death benefit and an investment and savings account that you may withdraw or take out a loan from at any time.
How Does Cash Value Life Insurance Work?
When you pay your premiums into a cash value life insurance policy, the premiums are split amongst different parts of the policy:
- Cost of the insurance: Part of your premiums go towards your death benefit which your loved ones will receive when you pass.
- Fees: Since your cash value is being invested, there will be management fees associated with your cash value life insurance.
- Cash value: The rest of your premiums will directly go into your cash value which helps the cash accumulate over time.
The cash value in your policy is separate from your death benefit, which means that when you pass, your beneficiaries do not have access to it. Cash value is a feature meant for the insured to access while living and anything left over will go to the insurer.
Types of Cash Value Insurance Policies
Whole Life Insurance
Whole life insurance provides lifelong coverage, and has a death benefit that builds cash value for your or your family’s future needs. Premiums for whole life policyholders stay level, meaning they won’t go up over time. The cash value in the whole life policy grows based on a mathematical formula that the insurer determines. As the insured, you’re limited in how much you can control your cash value as it grows based on how much your premiums are each year.
Universal Life Insurance
Universal life policies are flexible, meaning you can change your death benefit and premiums at any time. Unlike a standard whole life policy where the cash value grows based on the company, in a universal life policy, the cash value grows based on the economy’s current interest rates.
As the insured, you have more control over how much the cash value grows, as you may increase your premiums at any time you’d like, thus increasing your cash value. There are three types of universal life insurance:
- Flexible Universal Life Insurance: At any time while the policy is active, you may have the choice to increase or decrease your premiums and death benefit. Bear in mind that the cash value of your policy may accumulate slower than it did before if you decrease your premiums.
- Fixed Universal Life Insurance: You may choose to keep premiums level for your universal life policy. This means that your premiums will stay the same regardless of age or health. The cash value of your policy is going to grow at a fixed interest rate if you choose to keep your premiums fixed.
- Single-Premium Universal Life Insurance: This policy is a one-time payment for your universal life insurance, so you won’t have to make any payments on it in the future. The cash value of this policy will be how much cash you initially paid up-front. For example, if you make a lump-sum payment of $50,000 for your policy, your cash value is immediately $50,000 and will grow at a guaranteed interest rate.
Variable Universal Life Insurance
Variable Universal Life is a hybrid between traditional and standard universal life insurance. This policy has the same features such as permanent life insurance coverage and flexible premiums but is more expensive because of how its cash value accumulates.
The cash value in variable life insurance allows you to have more control over how it’s being invested through stocks, bonds, and mutual funds. Although your cash value can grow more quickly through these investment options, you’re at a greater risk of losing your cash value compared to a standard universal life.
Indexed Life Insurance
Indexed life insurance provides permanent life insurance coverage as long as premiums are paid. Indexed life insurance consists of an annual renewable term and cash value feature. This policy offers you a level premium one year at a time and is based on your age and health.
The cash value in this policy links to an index fund such as the Standard & Poor’s (S&P) 500 or NASDAQ 500 index fund. The insurer offers a minimum guaranteed rate of return so that if the index experiences a downturn, your cash is guaranteed to not go down. On the other hand, if the index performs well, your cash value may grow along with it. Indexed life insurance could give you more control of your cash value compared to a standard universal life, but there are less investment options than variable life insurance.
How to Access A Cash Value Life Insurance Policy
Pay Premiums With Cash Value
Also known as a paid-up policy, once there’s enough cash value that’s accumulated in your policy, you may have the option to pay premiums with your cash value. There are no fees to this option as you’re using your own cash value to pay premiums. With this option, you may be able to save money on recurring expenses.
Cash Value Withdrawal
While your policy remains active, cash value can be withdrawn tax-free at any point. Bear in mind that if you withdraw more cash than you’ve accumulated, you could be subject to paying income tax on your money. Depending on how much you decide to withdraw, it may reduce your death benefit or cancel your policy altogether.
Surrender Life Insurance Plan
At any point in time, you could surrender your life insurance policy and receive the cash value. In doing so, your death benefit will cancel out and if you were to pass, your loved ones could receive nothing to ease their financial burdens. Only consider surrendering your life insurance policy if you have another policy or other funds to financially help your family when you pass.
When surrendering your policy, you may be subject to surrender fees which will reduce your cash value. You could also be charged with income tax on your cash value, and if you have any outstanding loans on the cash, there may be more taxes incurred.
Take Out a Loan
You may take out a loan against your cash value without impacting your credit score. Insurance companies may offer lower interest rates compared to a traditional bank and the loan will remain tax-free as it’s not recognized as income by the IRS. However, like any other loan, you’re expected to pay it back with interest.
Sell Policy for a Life Insurance Settlement
Also known as a viatical settlement, a life settlement is when you choose to sell your life insurance policy for tax-free cash. This usually happens through a third party, broker, or a settlement company. The third party becomes the new owner of your policy and may pay your premiums in exchange for your death benefit when you die. A life settlement may be considered if you:
- Are unable to afford premiums for your life insurance
- Want to retire but need extra money to help you with retirement
- Experience cases of emergencies you can’t afford
- Are diagnosed as terminally-ill
Increase Death Benefit Payout
Standard universal life insurance offers two options in regards to your death benefit. The first option is a level death benefit, which means that your death benefit remains the same. This option is recommended for those who are 60 or older. The next death benefit option is an increasing death benefit, meaning your death benefit will increase over the years and recommended for those who are in their 50’s and younger.
Unlike a level death benefit policy, your cash value is tied to your death benefit with an increased death benefit policy. When you pass, your beneficiary, whom you’ve assigned to receive your death benefit, will get the death benefit on top of the accumulated cash value.
Disadvantages of Cash Value Life Insurance
High Premiums
Cash value life insurance may be more expensive than standard life insurance, such as a term life policy because part of your premiums goes towards growing your cash value. Term life may be less expensive because it doesn’t have features which you may withdraw or take loans from.
Fees
With a cash value life policy, there may be management fees associated with the policy in order to help your cash value grow. Throughout the years, the cost of management fees may cost more than you anticipated because it may take a longer time to see the accumulation of your cash value.
Capped Returns
With a cash value life policy, the insurance company may cap your returns on how much your cash value can gain. You may benefit from investing directly in stocks, mutual funds, or bonds if you want higher returns for your investments.
Who Should Consider A Cash Value Life Insurance Policy
Cash value life insurance may provide financial security while you’re living. Bear in mind that you may not see growth in your cash value for 2 to 5 years after the start of your life insurance policy. Cash value life policies could be beneficial for you through building a nest egg, also known as money set aside for the future, and using it as another source of retirement income planning.
Alongside other retirement plans such as an IRA or 401(k), cash value life policies offer tax-free retirement as your cash grows tax-deferred. Depending on which type of whole life insurance you choose, your cash value could experience upside growth potential with no cash value loss. This is beneficial for those who are conservative with their investments.