It’s not easy to shop for life insurance. It can be difficult to figure out which policy type, riders, and jargon (accelerated death, anyone?) make the most sense for your specific financial circumstances.
The concept of the cash value in life insurance is commonly misunderstood. Permanent life insurance policies frequently include this feature.
Policyholders can withdraw money from the cash value, which works like a savings account.
While cash value life insurance may appear to be a good alternative, it isn’t necessarily the best.
What Does Life Insurance Cash Value Mean?
Life insurance with a cash value feature usually earns interest or other investment gains and builds up without paying taxes on them.
Your premium payments go to three places with cash value life insurance:
In monetary terms,
To cover the cost of actually insuring you.
Fees and modifications to the policy.
As a result, only a portion of your payment will be converted to cash.
If you desire a cash value life insurance policy, you have several possibilities. Each type of policy builds cash value differently, but you can always get at it by taking out a loan, withdrawing money, or giving up the policy.
Whole life insurance offers a set monthly premium and a guaranteed death payout. The amount you pay for premiums does not alter over time. A minimum guaranteed rate of growth in cash value will be achieved. You can build up your whole life insurance cash value account more quickly if you receive company dividends and put them into it every year.
When compared to whole life insurance, universal life insurance offers more freedom. If there is enough money in the cash value account to cover the expenses of the policy, 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 containing investments you choose (variable universal life).
Guaranteed issue life insurance is a type of whole life insurance that is only offered in small coverage amounts, such as $20,000, and is usually only accessible in the United States. Some guaranteed issue plans will have a cash value, but because coverage quantities are minimal, the cash value will be small as well. 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 have your hands on that money?
If you wish to end the policy, you can also get your cash value. If you cancel the policy with the insurer, you’ll be paid the cash value less any surrender charges. The life insurance coverage will be terminated as a result of this action. If you cancel your policy within the first few years of purchase, you will usually be charged a surrender price. The charge for giving up the policy is a way for the insurance company to make up for the cost of giving you the policy.
Check out our rankings to locate the best cash value life insurance companies.
Borrow some money
One alternative is to take out a loan against your permanent life insurance policy’s cash value. Until you repay your loan in full, you will be charged interest.
A policy loan’s interest rate might be fixed or variable, depending on current market rates. The maximum policy loan interest rate is frequently determined by state law. The maximum fixed rate in Washington state, for example, is 6% per year, whereas the variable-rate must be between 4% and 8% per year.
If you die without repaying the loan, the outstanding loan total (including interest) will be deducted from your beneficiaries’ life insurance benefit. Some policyholders prefer to spend their cash value this way so that their beneficiaries will get less money from the policy.
An insurance loan also has the advantage of not showing up on your credit report.
Cash Value Withdrawal
Withdrawals from your insurance coverage are also available. The portion of your withdrawal that includes investment gains, sometimes known as “above base,” is taxable. Making a withdrawal, like taking a policy loan, lowers the future life insurance benefit to your beneficiaries.
Accept Cash in Exchange for the Policy
When you surrender your insurance policy, you are effectively terminating it. You can obtain the cash value of a policy less any surrender charges when you surrender it. Any overdue premiums or outstanding loan balances will be deducted by the insurance company. Even so, if you no longer desire the policy, getting some money back is preferable to going away empty-handed.
Payment of Premiums Using Cash Value
Depending on the policy, you may be able to use your cash value account to cover premium payments if you accumulate enough money in your cash-value account. If you’re having trouble making your payments, this option may be able to help you keep your life insurance policy active.
The policy may lapse if you deplete all of the cash value in the account, so keep track of your cash value.
By contacting your insurance company, you can find out the regulations for using cash value to reduce your premiums.
Participatory policies are policies that encourage people to participate.
Many whole life insurance policies are “participating,” which means that if purchased through a mutual insurance firm, the policy owner may be eligible for profits. Dividends can be taken as cash, increased to the cash value of your account, or used to pay premiums. You can also use your dividends to buy “paid up additions” to your life insurance policy, which will increase the amount your beneficiaries will get when you die.
A participating policy can help you save money on life insurance in the long run.
Riders for Additional Protection
Most types of life insurance contain policy riders that allow you to add extra coverage or benefits. An expedited death benefit is one of the most frequent, and it’s often provided by default. If you’re diagnosed with a terminal disease, you can receive your death benefit money while you’re still alive. It might help you pay for medical bills and other unforeseen expenses.
If you have specific medical problems, you can use similar riders for chronic disease and long-term care to access your own death benefit. Before you acquire your life insurance policy, ask your advisor about the rider alternatives.
Cash-Value Life Insurance Has Tax Benefits
Buying life insurance, particularly cash value life insurance, can have a number of tax advantages. The death benefit, like any other sort of life insurance, is tax-free for your beneficiaries. This is a significant benefit because life insurance payment amounts are typically rather large.
The overall cash value grows tax-free. The IRS doesn’t take a share as your cash value rises.
You also won’t have to pay taxes on the loan if you borrow money against the policy, just like you wouldn’t on a personal loan. While the policy is in effect, the loan is not taxable.
You may be taxed on the portion of the money that came from interest or investment gains if you withdraw cash value or take the surrender value and cancel the policy.
To avoid being surprised by a tax bill, it’s important to understand tax rules before taking money out.
When Should a Cash Value Policy Be Purchased?
While most individuals only need term life insurance, cash value life insurance might be advantageous in a select situations. To begin with, these policies are only practical for those who can afford them. Because of the cash value element and policy fees, premiums can be significantly higher than term life insurance for the same amount.
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 another tax-free savings account.
Some people with a lot of money use cash value plans to help their heirs pay inheritance taxes.
Cash Value Policies: A Word of Caution
Because some policies take a long time to accumulate any significant cash value, you may have to wait decades to receive a considerable sum. Other strategies are meant to increase cash value faster in the first few years.
When you die, the life insurance company normally gets the cash value. Your beneficiaries will receive the death benefit amount of the policy, less any cash value loans and withdrawals you made. Beneficiaries rarely get the death benefit plus the monetary value. Your beneficiaries would receive $980,000 if you had $1 million in coverage and a $20,000 loan.
Some companies offer the option of getting the death benefit plus cash value in exchange for paying higher premiums.
Look into term life insurance if you need life insurance to pay off a certain debt or for a specific period of time. It has no cash value, but it will pay out a death benefit amount 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 off your mortgage or until your children are financially independent. And, unlike certain forms of permanent life insurance, it won’t cost an arm and a leg. Term life insurance will provide you more bang for your buck if you don’t need insurance for the rest of your life.
Life insurance is intended to provide financial security to your loved ones in the event of your death. Cash value life insurance may seem like a good idea, but you shouldn’t pay the higher premium if you don’t need protection for life.