Cash value life insurance, also known as permanent life insurance or whole life insurance, is a type of life insurance policy that provides not only a death benefit to beneficiaries but also a savings component that accumulates over time. These policies are more expensive than term life insurance policies but offer more benefits and features. In this article, we will explain what cash value life insurance is, how it works, its pros and cons, and how to determine if it’s the right policy for you.
What is Cash Value Life Insurance?
Cash value life insurance is a type of permanent life insurance that provides a death benefit to beneficiaries upon the insured’s death. This policy also has a savings component that builds up over time, known as cash value. The cash value earns interest and grows tax-deferred, which means that you do not have to pay taxes on the growth until you withdraw the money. There are different types of cash value life insurance policies, including whole life, universal life, and variable universal life insurance.
Unlike term life insurance, which only provides coverage for a specific term, cash value life insurance policies provide coverage for the duration of the policyholder’s life as long as the premiums are paid.
Types of Cash Value Life Insurance
There are different types of cash value life insurance policies, each with its own features, benefits, and risks. Here are the three main types of cash value policies:
Type of Cash Value Policy |
Description |
|---|---|
Whole Life Insurance |
This policy guarantees a fixed premium and death benefit, and the cash value grows at a guaranteed rate. |
Universal Life Insurance |
This policy offers more flexibility in premium payments and death benefits, and the cash value grows at a variable rate. |
Variable Universal Life Insurance |
This policy offers flexibility in premium payments and death benefits, and the cash value is invested in different investment options, such as stocks and bonds. |
How Does Cash Value Life Insurance Work?
When you purchase a cash value life insurance policy, you pay a premium every month or year, which is divided into two parts: the cost of insurance and the savings component. The cost of insurance is the amount that goes towards the death benefit, while the savings component is the amount that goes towards the cash value account.
As you continue to pay premiums, the cash value account grows over time. The growth is tax-deferred, which means that you do not pay taxes on the gains until you withdraw the money. The interest rate on the cash value account is usually guaranteed for whole life insurance policies, while it varies for universal life and variable universal life policies.
You can access the cash value account in several ways, such as taking out a loan against the account, withdrawing money from the account, or surrendering the policy for its cash value. However, taking out a loan or withdrawing money from the account can reduce the death benefit and may have tax consequences.
Pros and Cons of Cash Value Life Insurance
Pros
- Permanent coverage: Cash value life insurance provides coverage for the lifetime of the policyholder, as long as the premiums are paid.
- Savings component: Cash value life insurance policies have a cash value account that grows over time, providing a tax-deferred savings component.
- Guaranteed death benefit: Whole life insurance policies have a guaranteed death benefit, which means that the beneficiaries will receive a fixed amount of money upon the death of the insured.
- Tax-advantaged: The growth of the cash value account is tax-deferred, which means that you do not pay taxes on the gains until you withdraw the money.
Cons
- Expensive premiums: Cash value life insurance policies are more expensive than term life insurance policies, which may make it difficult for some people to afford.
- Complexity: Cash value life insurance policies are more complicated than term life insurance policies, and it can be challenging to understand the different features and benefits.
- Lower returns: The returns on the cash value account may be lower than other types of investments, such as stocks or mutual funds.
- Reduced death benefit: Taking out a loan or withdrawing money from the cash value account can reduce the death benefit. Additionally, surrendering the policy for its cash value can result in no death benefit.
Is Cash Value Life Insurance Right for You?
Cash value life insurance policies may be right for you if:
- You want lifelong coverage.
- You want a tax-deferred savings component.
- You have a high net worth and want to leave a legacy to your beneficiaries.
Cash value life insurance policies may not be right for you if:
- You only need coverage for a specific term.
- You do not want to pay higher premiums for additional features and benefits.
- You can obtain higher returns on other types of investments.
FAQ
What is the difference between cash value life insurance and term life insurance?
The main difference between cash value life insurance and term life insurance is the duration of coverage. Cash value life insurance provides coverage for the lifetime of the policyholder, while term life insurance provides coverage for a specific term, such as 10, 20, or 30 years. Additionally, cash value life insurance policies have a savings component, while term life insurance policies do not.
How is the cash value account different from the death benefit?
The cash value account is the money that accumulates over time in a cash value life insurance policy. This account grows tax-deferred and can be accessed through loans, withdrawals, or surrendering the policy. The death benefit is the amount of money that is paid to the beneficiaries upon the death of the insured. The death benefit is usually tax-free and can be used to cover expenses such as funeral costs, outstanding debts, and living expenses.
Can I change my coverage amount with a cash value life insurance policy?
Yes, some cash value life insurance policies allow you to adjust your coverage amount by increasing or decreasing your premiums or death benefit. However, this may have additional fees and may require a medical exam or underwriting.
If you stop paying premiums on a cash value life insurance policy, the policy may lapse or terminate. If the policy lapses, you may be able to reinstate it by paying the back premiums and any fees. If the policy terminates, you may be able to receive the cash surrender value of the policy, which may be lower than the death benefit.
Can I borrow money from the cash value account?
Yes, some cash value life insurance policies allow you to borrow money from the cash value account by taking out a loan against the account. The loan must be paid back with interest, and failure to pay back the loan can reduce the death benefit.
Is the cash value account subject to taxes?
No, the cash value account is not subject to taxes as long as it remains in the policy. However, withdrawing money from the account or surrendering the policy for its cash value may have tax consequences.
Conclusion
Cash value life insurance can be a valuable tool for those who want lifelong coverage and a tax-deferred savings component. However, these policies are more expensive and complicated than term life insurance policies and may not be suitable for everyone. It’s essential to review your financial goals and needs and speak with a financial advisor to determine if cash value life insurance is the right policy for you.