Shopping Cash Value for life insurance can be challenging. With so many different policy types, riders, and confusing language (rapid death, anyone?), it can be difficult to figure out what is best for your specific financial circumstances.
Many people are unaware of the concept of the cash value in life insurance. This is a typical clause in permanent life insurance policies.
People who own policies can take money out of the cash value, which works like a savings account.
While cash value life insurance may appear to be a good idea, it isn’t always the best decision. Here’s everything you need to know about it.
What is Life Insurance Cash Value?
Life insurance that has a cash value feature usually earns interest or other investment gains and builds up without having to pay taxes on them.
Your premium payments for cash value life insurance go to three different places:
Into the monetary value
- in the direction of the cost of actually insuring you.
- Changes in policy fees and changes
- As a result, only a portion of your payment will be redeemed in cash.
If you desire a cash value life insurance policy, you have numerous possibilities. Each type of policy builds cash value differently, but you can always get at it with a loan, a withdrawal, or a surrender.
Whole life insurance has a fixed monthly premium and a death payout that is guaranteed. Your subscription payments will stay the same over time. The cash value will increase at a set minimum rate. You can build up your entire life insurance cash value account faster if you earn company dividends and put them into it every year.
Whole life insurance offers less flexibility than universal life insurance. If there is enough money in the cash value account to pay the policy’s costs, you may be able to adjust your death benefit and lower your premiums with some types of universal life insurance. The growth of your cash value can be linked to an index like the S & P 500 (indexed universal life insurance) or sub-accounts with investments you choose (variable universal life).
Guaranteed issue life insurance is a type of whole life insurance that is only offered in small quantities of coverage, such as $20,000. Some guaranteed-issue insurance will include cash value; however, the potential cash value will be limited because of the lower coverage amounts. Guaranteed-issue life insurance can’t be turned down, but if you die within two or three years of buying it, your beneficiaries may not get the full payout (rules vary by company).
How are you going to get your hands on the cash?
You can take money out of it in cash value or take a loan against it and use it for whatever you want: an emergency, supplementing retirement income, paying premiums, or anything else.
If you decide to cancel the policy, you can reclaim your monetary value. You’ll get the cash value amount minus any surrender charges if you cancel the policy with the insurer. This move cancels your life insurance policy. If you cancel the insurance during the first few years of purchasing it, you will usually be charged a surrender fee. The surrender charge is a mechanism for the insurer to recoup some of the costs associated with issuing the policy.
See our rankings to find the best cash value life insurance companies.
Here’s more information about each choice
Obtain a Loan
Borrowing against the cash value of your permanent life insurance policy is one alternative. Until you repay your loan in full, it will accrue interest.
The interest rate on a policy loan can be set or variable, depending on the insurer’s calculations based on current market rates. The maximum policy loan interest rate is frequently set by state law. According to Washington state, the maximum fixed rate is 6% per year, and the variable rate must be between 4% and 8% per year.
If you don’t return the loan and die, the outstanding loan sum (including interest) will be deducted from your beneficiaries’ life insurance benefits. Some policyholders prefer to spend their cash value this way so that their beneficiaries get less money from the policy.
An insurance loan also has the advantage of not appearing on your credit report.
Money Can Be Withdrawn From Cash Value
You can also make withdrawals from your insurance coverage. The percentage of your withdrawal that includes investment gains, sometimes known as the “above base” portion, is taxable. Making a withdrawal, like taking a policy loan, would reduce the life insurance payout to your beneficiaries in the future.
Cash in exchange for the policy
When you surrender an insurance policy, you are effectively terminating it. You can recover the cash value of an insurance policy minus any surrender charges when you surrender it. Any unpaid premiums or outstanding loan balances will be deducted by the insurance company. Still, if you no longer desire the coverage, getting some money back is preferable to going away empty-handed.
Paying Premiums with Cash Value
Depending on the policy, you may be able to utilize your cash value to offset premium payments if you save up enough money in your cash-value account. If you’re having trouble making payments, this option may be able to help you keep your life insurance policy in force.
If you delete the account’s cash value, the insurance may lapse, so keep track of your cash value.
Find out from your insurance company what you need to do to put money toward your premiums.
Participation in policy
Many whole life insurance policies are “participating,” which means that if the policy is purchased from a mutual insurance firm, the policy owner may be eligible for dividends. Dividends can be cashed out, added to your cash value, or used to cover premium payments. You can also use dividends to buy “paid-up additions” to your life insurance policy, which increases the amount of money your beneficiaries will get when you die.
A participating policy can help you save money on your life insurance premiums.
Adding Riders for Additional Protection
Most types of life insurance allow policy riders to be added to add extra coverage or features. An expedited death benefit, which is often incorporated automatically, is one of the most prevalent. If you’re diagnosed with a fatal illness while still living, you can obtain your death benefit. It can help with medical bills and other unforeseen expenses.
If you have specific medical problems, similar riders for chronic disease and long-term care will allow you to access your death benefit. Before you buy a life insurance policy, talk to your agent about the options for riders.
Cash Value Life Insurance Has Tax Benefits
Specifically, purchasing life insurance, specifically a cash value life insurance policy, can provide various tax benefits. As with any sort of life insurance, the death benefit is tax-free to your beneficiaries. This is a significant benefit because life insurance payouts are typically quite large.
Another tax benefit is that the whole cash value accumulates tax-deferred. The IRS doesn’t take a share as your cash value increases.
You won’t have to pay taxes on the loan if you borrow money against the policy, just as you wouldn’t on a personal loan. As long as the insurance is in effect, the loan is not taxable.
You may be taxed on the percentage of the money that came from interest or investment gains if you withdraw cash value or take the surrender value and terminate the policy.
To avoid being surprised by a tax bill, it’s important to understand tax rules before taking money out.
When is it a Good Idea to Buy a Cash Value Policy?
While term life insurance provides adequate coverage for most people, cash value life insurance might be beneficial in a few situations. To begin with, these policies are only beneficial to those who can afford them. Because permanent life insurance has a cash value component and policy fees, premiums can be much higher for the same amount of coverage than term life insurance.
A cash value insurance policy could be a good choice for people with high incomes who have already put as much as they can into their retirement accounts and want a second tax-free savings account.
Some people with a lot of money use cash value plans to help their heirs pay inheritance taxes.
Cautionary Notes on Cash Value Policies
Because some policies take a long time to accumulate any considerable monetary value, you may have to wait decades before you can obtain a significant sum. Other policies are designed to accumulate cash value more quickly in the first few years.
Any cash value will normally return to the life insurance provider after you die. Your beneficiaries receive the death benefit amount of the policy, minus any loans and cash value withdrawals you made. Beneficiaries rarely receive both the death benefit and the cash value. Your beneficiaries would receive $980,000 if you had $1 million in coverage and a $20,000 loan due.
Some companies let beneficiaries choose to get the death benefit plus the cash value in exchange for paying higher premiums.
Look into term life insurance if you need life insurance to cover a specific debt or a specific period. It doesn’t have a cash value, but it will pay you a death benefit of your choice if you die during the policy’s term, which can be 10, 20, or 30 years.
Term life insurance is ideal for covering the years you’re paying down a mortgage or until your children are financially self-sufficient. And, unlike certain forms of permanent life insurance, it won’t cost you an arm and a leg. Term life insurance will provide you more bang for your buck if you don’t need coverage for the rest of your life.
Life insurance is intended to provide a financial safety net for your loved ones in the event of your death. While cash value life insurance may appear appealing, it makes no sense to pay the higher premium if you won’t need coverage in the future.