What is Cash Value Life Insurance?
Cash-value life insurance is a form of permanent life insurance — lasting for the life of the holder — that features a cash value saving component. Policyholders can use the cash value for various purposes, such as a source of loan or cash or to pay policy premiums.
- Cash-value life insurance is more expensive than term life insurance.
- Unlike term life insurance, cash value insurance policies do not expire after a certain number of years.
- Policyholders can borrow against cash value life insurance policies.
How Cash Value Life Insurance Works
Cash value insurance is permanent life insurance as it provides coverage for the life of the policyholder. Traditionally, cash value life insurance has a higher premium than term life insurance because of the cash value element. Most cash-value life insurance policies require a fixed level premium payment, of which part is allocated to the cost of insurance, and the rest is deposited into a cash-value account.
The cash value of life insurance earns a modest interest rate, with a deferred tax on retained earnings. Therefore, the cash value of life insurance will increase over time. As the cash value of life insurance increases, the insurer’s risk decreases, as the accumulated cash value offsets part of the insurer’s liabilities.
Examples of Cash Value Life Insurance
Consider a policy with a $ 25,000 death benefit. This policy has no outstanding loans or prior cash withdrawals and an accumulated cash value of $ 5,000. Upon the death of the policyholder, the insurance company pays a full death benefit of $ 25,000. The money collected into cash value now belongs to the insurance company. Since the cash value is $ 5,000, the actual cost of the liability to the insurance company is $ 20,000 ($ 25,000 – $ 5,000).
Whole life, variable life, and universal life insurance are all examples of cash value life insurance.
Advantages and Disadvantages of Cash Value Life Insurance
The cash value component serves as a living benefit for policyholders from which they can obtain funds. The net cash value of life insurance is the balance left by the policyholder or their beneficiary once the insurance company deducts its fees or any expenses incurred during the ownership of the policy. There are several options for accessing funds. For most policies, partial surrender or withdrawal is allowed but this can reduce the death benefit.
Tax is deferred on income until withdrawn from the policy and distributed. Once distributed, the income will be taxed at the policyholder’s standard tax rate. Some policies allow unlimited withdrawals, while others limit the number of draws that can be taken over a period or calendar year. Some policies limit the amount available for removal (e.g., a minimum of $ 500).
Most cash-value life insurance arrangements allow loans from the cash value. Just like any other loan, the issuer will charge interest on the outstanding principal. The outstanding loan amount will reduce the death benefit dollar for dollar in the event of the policyholder’s death before full repayment of the loan. Some insurers require repayment of loan interest, and, if not paid, they can deduct interest from the remaining cash value.
The cash value can also be used to pay policy premiums. If there is a sufficient amount, the policyholder can stop paying premiums out of pocket and have a cash value account to cover the payment
Why consider cash value life insurance?
Policyholders can borrow as opposed to accumulated savings, which earn modest interest rates. Since it is called a permanent policy, cash life insurance will not expire after a few years.
Should I consider buying a cash value life insurance policy?
Those looking to build a nest egg in a matter of decades may want to consider cash value life insurance as a savings option, in addition to a retirement plan such as an IRA or 401 (k). Please note that cash value usually does not begin to accrue until two to five years have