What Is Cash Value Life Insurance?

While shopping for life insurance, you might encounter the term “cash value” quite often. It is an attractive idea, but it can be a bit confusing.

Life insurance of the regular type is made only for payouts when the policyholder dies. On the other hand, cash value policies perform one more thing. They accumulate savings while you are alive.

Such a combination of functions makes these policies more costly and valuable to some extent. Some people become very attached to them, while others consider them redundant.

Comprehending how cash value life insurance works will facilitate your decision about whether it is compatible with your monetary aims. Let’s dig deeper to see how these policies differ from each other.

What Exactly Is Cash Value in Life Insurance?

Cash value is the part of permanent life insurance that functions as a savings plan.

A portion of your premium will be spent on the death benefit. The remaining money will be put into a cash account that increases in value over the years.

It is like having two products rolled into one. You get life insurance coverage and a savings account.

This cash value is not subject to tax until it is withdrawn. So, the growth is tax-deferred.

The longer the policy is in your possession, the more cash value it has. This is distinct from the death benefit.

How Does Cash Value Life Insurance Differ From Term Life Insurance?

They differ greatly in several ways.

Term life insurance is just a basic protection. You pay premiums for a certain period and only get coverage for that time. If you die within the term, your beneficiaries will be paid. Once the term ends, the coverage also stops.

The contract of the term policies is not attached to any cash value. You cannot get any funds from these policies during your lifetime.

Cash value policies are for life. They will not expire as long as you pay your premiums. They contain the savings feature that is absent in term policies.

Based on scientific estimation, the number of permanent life insurance policies with cash value accounts sold in the USA is about 40% of the total individual life insurance policies.

What Types of Life Insurance Build Cash Value?

The cash value feature is present in four main types of life insurance.

• Whole Life Insurance

This used to be the most classic option. Your premiums will remain unchanged for the rest of your life, and the cash value will increase at a rate guaranteed by the company.

The increase is foreseeable and secure. The profits are not very high but are steady.

• Universal Life Insurance

It gives you more permission for variation. Within the confines, you can change the premium and death benefit.

The money added to the cash value is invested, and the account receives interest that depends on the current rates. The market will determine the fluctuations of the returns.

• Variable Life Insurance

It is designed for you to put the cash value into sub-accounts, much like mutual funds. The return on your investment depends on how well the fund does.

On the one hand, higher potential returns can be generated; on the other hand, there are higher risks. You might find yourself in a situation where you lose money due to poor investments.

• Indexed Universal Life Insurance

It links the increase in cash value to an equity index like the S&P 500. So, you get some benefits of rising markets and protection against losses.

Usually, there is a limit on returns and a floor that prevents losses.

How Does Your Cash Value Actually Grow?

The growth methods depend on the type of policy.

Companies that offer whole life policies calculate and add a fixed percentage to the cash value every year, as per the contract guarantees. In addition, several companies may also provide their clients with dividends that help the cash value grow.

The interest rate on universal life policies is determined by the current market rates. The company always sets a minimum that it will guarantee, but the actual rate may change occasionally.

Variable policies increase the value depending on the type of investment the policyholder chooses. The policyholder can decide to invest in one of several sub-accounts and then the return will be the same as their performance.

Indexed policies are credited when the chosen index records positive performance. For instance, if the index goes up 8% and your cap is set at 10%, you will get the entire 8%. But if the index goes up 15%, you will only get 10%.

Can You Access Your Cash Value While You’re Alive?

This is definitely one of the main reasons that policies are favored over others.

There are multiple ways you can do it:

• Withdraw cash directly (as allowed by policy terms)
• Get a loan on the cash value at low-interest rates
• Employ it for the payment of policy premiums
• Release the policy and receive the total cash value that has been accumulated

Withdrawals made up to the amount of your basis (total premiums paid) are not subject to tax. Any excess over your basis will be treated as taxable income.

Taxes are not charged on policy loans. Yet, the death benefit will be reduced by those loans that you have not paid.

Findings of the study convey that practically 60% of permanent policyholders eventually opt for lending against or making a withdrawal from their cash value.

You may also read: What Age Does Life Insurance Expire?

What Are the Advantages of Cash Value Life Insurance?

Besides basic coverage, these policies bring a lot of good stuff.

• Lifetime Protection

It is the most guaranteed thing that you will be covered for your whole life. No need to fear you will end up out of coverage at an advanced age.

• Tax-Deferred Growth

The cash value will increase over time and be free of yearly taxes. This is advantageous for accumulation over many years.

• Flexible Access

If you are in need of money, it could be for emergency, retirement, or some other case, you can turn to your cash value.

• Forced Savings

By regular payment of premiums, one is forced to save. Most people find it hard to do continuous saving otherwise.

• Creditor Protection

In many states and jurisdictions, cash value is protected from creditors. Your exact location determines where this protection applies.

Final Thoughts

Cash value life insurance merges the guaranteed death benefit with the policyholder’s savings account.

These types of insurance are significantly more expensive than term life, but will cover you for your whole life and allow you to manage your finances in a flexible way. You can think of them as the right instrument for an estate plan or business program or simply to help you accumulate more in your retirement fund.

On the other hand, they are not the ideal ones for everyone. Most individuals will be better off if they opt for a term life policy and separately invest in their retirement.

Deciding on your own requires the analysis of your financial position, goal setting, and discipline if you want to invest. You can also try a financial advisor for some professional and impartial advice – an advisor who does not earn commissions from the sale of securities.