In exchange for your monthly payments, a life insurance policy usually guarantees two things: coverage and a death benefit for your loved ones. However, not all life insurance plans are created equal – some can be more beneficial than others, depending on your financial goals.
Enter cash value life insurance. Aside from the usual death benefit, you also get the unique advantage of a savings component.
This sounds great in theory, but does it work for every policyholder? Is it the right choice for you?
To answer this question, this guide will cover what cash value life insurance is, the types of policies that fall under it, how to use your plan’s cash value, and how this type of policy measures up against term life insurance.
What Is Cash Value Life Insurance?
Cash value life insurance refers to any permanent life insurance policy that includes a cash value savings component on top of the face amount. Your insurance company splits every premium payment three ways – a portion each for insurance costs, general insurance fees, and your cash value.
Your beneficiaries won’t have access to the cash value, but there are other ways to maximize it. Your cash value can be used for investments, paying premiums, insurance loans, or even as loan collateral.
How It Works
Because cash value life insurance is permanent, its coverage will last as long as your premiums are kept up-to-date. Continuously paying off your premiums enables you to accrue tax-deferred interest at a modest rate. This means that your policy's cash value is free from income tax until you borrow against it or relinquish the policy to access its cash surrender value.
Despite its steady growth, cash value policies generally take several years before any meaningful gains are achieved. This is because the first few years of your policy premium payments go toward paying off insurance fees rather than padding your cash value.
Advantages Of A Cash Value Life Insurance Policy
One of the most significant advantages is the stability of a whole life policy while still having a sizable death benefit. You might even be able to adjust your policy’s death benefit, but this varies per insurer or insurance company.
Furthermore, when a death benefit is finally paid out to your family, they won’t face any income taxes or extra charges when receiving a lump sum. This is also true if you relinquish your policy to reap the cash surrender value.
Another advantage is the cash value and its potential uses. For example, your policy may become self-sustaining after a few years if you use the cash value to pay your premiums. Likewise, your policy’s savings component also functions as an easily accessible source for loans.
Disadvantages Of Cash Value Life Insurance
Older policyholders may find cash value policies to be significantly more expensive than the alternatives. This is because the cost of premiums might eventually end up bigger compared to your gains. However, cash value life insurance is still viable for the vast majority of potential policyholders.
Types Of Cash Value Life Insurance
Life insurance companies usually have a wide range of life policies with a cash value component. This section discusses the different types of life insurance, how each policy builds cash value, and a few key differences you need to know before deciding on the best life insurance for you.
Whole Life Insurance
A whole life insurance policy is the most basic and rigid form of all permanent life plans. Premium payments remain stagnant while the policy is active – this stability also lends itself to your policy's cash value.
Like cash value life insurance, whole life insurance cash value is guaranteed by insurance companies and will continue to grow over time. This cash value account accrues interest based on the rate given to you after you request life insurance quotes, making whole life insurance a predictable and stable alternative to more volatile permanent life insurance policies.
Universal Life Insurance
A universal life insurance policy is more complicated than other whole life insurance policies, which sometimes results in more conservative policyholders putting their money elsewhere. Unlike its stabler counterparts, this type of life insurance builds cash value based on current market interest rates.
When policyholders pay premiums, a relatively small portion of their money goes toward insurance fees and overhead, while the rest are funneled into other investments. This type of life insurance best suits individuals with an appetite for risk and who are hands-on with their money.
Indexed Universal Life Insurance
Indexed universal insurance is a permanent life insurance policy that builds value based on stock market indexes (e.g. S&P 500, Nasdaq Composite) chosen by your insurance company. Given its formidable investment component, your family may be able to obtain significant gains, but this comes at the cost of a fixed interest rate.
Another important thing to consider is the death benefit’s flexibility. This whole life insurance policy allows a policyholder to adjust their policy’s face value whenever they need to, which can come in handy if your financial or health status changes.
Variable Universal Life Insurance
Like other universal life insurance policies, this variable life cash value policy combines your cash value account investments with the comfort of an adjustable death benefit. However, the main difference is that all investments made with this policy are sliced into “sub-accounts” rather than one large cash value account.
Because this policy’s death benefit is entirely separate from the investment component, policyholders don’t need to worry about their beneficiaries even when their chosen securities perform poorly. Users may also take out a loan against the policy’s cash account.
Note that this policy can be risky. Therefore, this insurance best suits policyholders that have assessed the state of their money and potential savings before buying.
Cash Value Life Insurance vs Term Life Insurance
The main difference between cash value life insurance and term life insurance is the length of their coverage. A cash value life insurance policy is permanent, meaning its coverage never expires. Unlike cash value insurance, term life insurance only provides coverage for a set period and won’t pay your family a death benefit if it expires before you pass away.
Another significant difference is cost, although this may depend on your chosen insurance company. Compared to cash value insurance, term life insurance usually costs significantly less. This can be attributed to its limited life insurance coverage and straightforward premium payment scheme.
How To Use Your Cash Value
There are many ways to make cash value life insurance work for you. For example, some people might use it to take a loan for auto insurance or car insurance. Others may want to funnel it back into their policy by using it to pay premiums or increase the death benefit.
Here’s how you can use your cash value.
Pay Your Insurance Premiums
Like most permanent insurance life, cash value payments can become quite costly over time. Insurers generally tailor your monthly payments to your specific needs, but make sure to be particularly mindful of increased payment requirements. We recommend considering tapping into your life insurance policy’s cash value to pay off inflated premiums due to policy adjustments.
As Collateral For A Loan
Many people use their life insurance policy’s cash value as a loan. For example, some may take out loans for car insurance, housing payments, or other big-ticket purchases.
While it may seem counterproductive to your long-term financial goals, loans taken against your cash value have lower loan interest rates than traditional avenues, which results in less money spent over time. However, make sure to properly assess your loan's cost versus advantage before contacting your insurance company.
Increase Your Death Benefit
If you’re not in the market for an easy loan, there’s always the option of increasing your death benefit with your permanent life insurance’s cash value. Increasing your death benefit may require adjusting the terms of your policy and usually results in elevated premium requirements.
Many policyholders redirect funds from their cash value back into their permanent life insurance to cover the costs of this larger death benefit, similar to the process of taking out loans against your policy.
Cash value life insurance is an excellent way to incorporate a savings account into your life insurance plan. However, it can also be complex and difficult to understand. That’s why we recommend connecting with a financial adviser before making any commitments.
If you’re in need of financial advice, contact Wesley LLC and we’ll help you find the best kind of cash value life insurance for your needs!