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How to Determine if Cash Value Life Insurance Is Right for You

A cash-value life insurance policy is a permanent policy that accrues an additional cash value through interest in addition to the policy death benefit. The named insured on the policy can treat this cash value as a form of investment and can often withdraw or borrow against the cash value while the policy is in effect.

What is cash value life insurance?

Life insurance policies can be divided into two coverages: cash value policies and term policies. Both have different benefits based on what the insured wants to accomplish.

  • Term life insurance. Term life policies offer coverage for a set period. Because the insurance has a set end date, this life insurance often allows the insured to purchase a large death benefit sum for a lower premium. Those looking for simple coverage at a reduced rate find these policies beneficial.
  • Cash value life insurance. Cash value life insurance is also called permanent life insurance, as the policy remains effective as long as premiums are paid. The policy also provides two benefits: the death benefit paid out to beneficiaries when the insured dies and the cash value, which accrues interest throughout the insured's life.

How does cash value life insurance work?

Cash value life insurance applies a portion of each premium payment to the policy's cash value. Because only a small amount goes toward this benefit, the cash value is usually inaccessible until the policy has been in effect for 2–5 years. After the period passes, the named insured can access the cash value according to the policy terms and conditions.

It is important to note that the cash value is accessible only during the insured’s lifetime. Once the insured passes away, only the death benefit is typically paid out to beneficiaries, and the cash value returns to the insurance company. Otherwise, the cash value functions similarly to a tax-deferred savings account while the insured is alive.

Types of cash value life insurance policies

How the cash value grows in the insurance policy, and its rate depends on the permanent life insurance policy type. Below are three common permanent life insurance policies and how they accumulate cash value.

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Whole life

Whole life insurance typically carries the least risk and conservative growth rates for the cash value within the policy. However, this also means these coverages are much easier to handle and require less attention.

  • The whole life insurance cash value grows at a fixed interest rate set each year by the company within the insurance policy.
  • Some whole life policies let the insured pay for a shorter time, such as 10 year (otherwise known as 10-pay whole life policies) or until the insured turns 65.
  • Premiums for these shorter policies are higher to fund the death benefit in a shorter time.

Universal life

Universal life insurance is a lower risk because there is a guaranteed rate at which the cash value will grow. However, there is a potential for higher interest rates as the insurance company invests the cash value and accredits the account with a portion of the dividends.

  • The cash value for a universal life policy grows when the insurance company invests a portion of the premiums. The returns are accredited to the policy tax-deferred.
  • Regardless of how the invested portion of the premiums performs, there is a minimum return benefit guaranteed by the insurance company.
  • Many insurance companies will keep the policy in effect as long as a set minimum premium amount is paid.

Variable life

Variable life contains the most risk and the greatest potential for growth of the policy's cash value because investments are controlled by the insured. However, this also requires the insured to be actively involved in the policy compared to other cash-value life insurance forms.

  • The death benefit and the cash value for variable life policies can fluctuate.
  • The insurance company provides the insured with information concerning different accounts made up of portfolios of different stocks, bonds, and other investments.
  • The insured chooses the accounts to invest the insurance premiums in, resulting in the potential for a high cash value life insurance policy and a higher risk.

How to use the cash value of a life insurance policy

Perhaps the most appealing part of a cash-value life insurance policy is the versatility of using the accumulated cash value. There are often four options for using the cash value: withdrawing, taking out a loan, surrendering the policy, and paying future premiums.

Make a withdrawal

Withdrawals of the cash value can be made up to the amount of premiums paid toward the policy while remaining tax-deferred. All additional withdrawals are considered taxable income once the amount paid into the policy is withdrawn. One should be careful when making these withdrawals as they can ultimately impact the death benefit amount.

Take out a loan

Oftentimes, a loan can be taken out against the permanent life insurance cash value, meaning a loan can be taken up to the amount of the cash value. However, this loan can accrue interest over time. The benefit to a loan vs. a withdrawal is that the loan is not considered taxable income, and should the insured die before the loan is paid off, the remaining balance is simply withdrawn from the death benefit.

Surrender the policy

Surrendering the policy is simply a cancellation. There will no longer be life insurance coverage for the insured, but they will receive the cash surrender value of life insurance. Simply put, the insured would receive the premiums paid into the cash value portion of the policy with the accrued interest and any policy surrender fees, taxes, loans, or unpaid premiums subtracted.

Pay future premiums

This benefit of cash-value life insurance is beneficial for those with inconsistent cash flows. Should the insured be short on cash or simply desire to stop paying premiums for a time, one can use the accrued cash value of the policy to pay future dividends. This feature tends to make permanent life policies more stable but can cause the life insurance policy to lapse if all of the cash value is depleted.

Cash value life insurance: things to consider

There are several pros and cons when considering a cash-value life policy for your insurance needs. No insurance policy is to be considered the best option for everyone.

While cash-value life insurance policies are versatile, there is no one-size-fits-all regarding life insurance policies. However, these principles help to outline the benefits and drawbacks one might expect. For those who weigh the cost, cash value life insurance can be a powerful tool in a person's financial planning.

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