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A brief guide on cash value life insurance policies

Life Insurance and Annuities
by Lisa Jiang
Understand how the cash value of life insurance policies work, how to claim the cash value and the types of cash value life insurance available.
Understand how the cash value of life insurance policies work, how to claim the cash value and the types of cash value life insurance available.

Cash value life insurance is a term that applies to most permanent life insurance policies.

With cash value insurance, policyholders enjoy a growable and accessible asset in a cash value account, in addition to a death benefit. But how does this type of policy differ from term life insurance and what can policyholders do with their cash value?

This brief guide will explain how cash value insurance works, which policies it generally applies to and how insureds can access their policy's cash value.

What is cash value life insurance and how does it work?

Unlike term life insurance, which only offers a death benefit, accrued cash from a cash value policy can be withdrawn or borrowed against while the insured is still alive, helping provide financial security in case of an emergency or unexpected expense.

Certain policies accrue cash value differently than others. Here are a few examples:

Whole life insurance

For this type of policy, cash value accumulation grows at a guaranteed, fixed rate of return that's set by the insurance company. Growth can be modest with whole life insurance, but it's steady. There's also generally a higher premium compared to other types of permanent policies, as a portion goes towards building cash value.

Universal life insurance

A universal life policy offers more flexibility in terms of premium payment amounts and death benefits than other types of life insurance and starts to generate immediate cash value from the first payment. Cash value growth is tied to the policy's interest crediting rate, which is influenced by prevailing interest rates and investment performance. Some universal life policies offer a minimum guaranteed interest rate that ensures a baseline of growth for the cash value account.

Variable universal life insurance

Variable life insurance allows policyholders to invest the cash value in a variety of investment options such as stocks, bonds and mutual funds, and cash value growth depends on the performance of those investments. Because of the nature of these investments, this type of policy typically carries more risk, however, there's potential for higher returns compared to other policies.

Indexed universal life insurance (IUL)

IUL offers cash value growth linked to a specific stock market index, such as the S&P 500. The policy's cash value grows based on the performance of the chosen index. It's often subject to certain limits and participation rates set by the insurance company. IUL provides the opportunity for higher growth potential than traditional universal life insurance but with downside protection.

Can you cash in a policy while you're still alive?

One of the main draws of cash value insurance is that there are ways for policyholders to access the policy's value while they're still alive. This comes in handy to deal with unexpected expenses, such as medical bills or necessary home repairs.

In such cases, there are a few ways that people can take advantage of cash value:

  • Loan: Borrowing money from the cash value of a policy has its benefits. When taking out a loan, it uses the cash value as collateral and, since a policyholder is technically borrowing money from themselves, a credit check isn't often required. Plus, these loans typically have low interest rates and flexible repayment options.
  • Withdraw: Making a withdrawal from the cash value of a policy is usually allowed in most circumstances, however, it will reduce the death benefit coverage amount of the policy. This means beneficiaries will be left with less money to cover expenses, such as funeral costs, when the policyholder passes.
  • Surrender: When surrendering a policy to the insurance company, policyholders will receive the cash surrender value, which is typically the current cash value minus any surrender fees. Fees vary between insurance providers.

Permanent policies that accumulate cash value, and convertible life insurance policies that can be changed to one that accrues cash value, are the better options for life insurance if a policyholder suspects they may need to access the cash at some point.

Term life insurance does not accrue cash value, therefore it cannot be borrowed from.

Are there any cons to a cash value life insurance policy?

Like any investment, cash value insurance policies do carry a few implications. However, when they are managed responsibly and within reason, there typically isn't anything major to worry about. That said, here are a few good-to-knows about cash value life insurance:

  • They are usually more expensive. In general, cash value policies have a higher premium and are therefore more expensive than other options, like term life insurance.
  • They take time to accrue value. Cash value accumulation doesn't happen overnight. For it to pay a reasonable dividend, policyholders must be patient.
  • Payouts may be subject to income tax. While the death benefit amount of cash value life insurance is non-taxable and beneficiaries will not owe anything to the IRS after a policyholder's passing, loans, withdrawals and surrenders may be subject to tax.
  • They can be more difficult to manage. Because there are more bells, whistles and moving parts that come with cash value insurance, they can be more difficult to understand and manage than other, more straightforward policies.
  • The policy could collapse. For certain types of policies, the death benefit amount could collapse if the premium stops being paid.
  • The death benefit may be reduced. Unpaid loans that have been borrowed against the cash value will reduce the death benefit coverage for beneficiaries.

Cash value life insurance is a classification that includes a variety of permanent policies. Like any type of life insurance or investment, they can offer a lot of value but come with a few drawbacks as well. At any rate, it's important to understand the different types of life insurance policies available to make the best decision.

To learn more about cash value life insurance, how it compares to other policy types and what makes the most sense for you and or your organization, contact Lewis & Ellis today.



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