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How Does Cash Value Life Insurance Work?
Cash value life insurance refers to any life insurance policy that includes both a death benefit and a savings component. Universal and whole life insurance policies both fall into this category. These life insurance policies build a cash value over time that the policy owner can access during their lifetime.
Every life insurance policy has a face value. Also known as the death benefit, the face value is the amount that the insurance company pays out to your beneficiaries when you die.
Cash value life insurance policies add a second feature. With these policies, a portion of each premium payment goes into a separate account, where it accrues tax-deferred interest. The balance of this account is the cash value. Cash value is only available with permanent life insurance policies, whereas term life insurance provides a face value only.
What Types of Life Insurance Offer Cash Value?
Whole life, universal life and variable life insurance policies offer a cash value component. While they’re all types of permanent life insurance, they differ greatly in how premiums work and how cash value grows.
A whole life insurance policy offers fixed premiums and cash-value interest rates. A portion of every premium payment made for a whole life policy is placed into a separate account. This fund serves as a tax-deferred savings or investment account and becomes the policy’s cash value. The cash value will increase over time as the insurance company’s assets provide returns as more premium payments are made.
A universal life policy has flexible interest rates with a floor to protect against significant market losses.
With a variable life policy, you can choose where to invest your cash value, and its growth will depend on how well your investments perform. The cash worth of the policy is made up of the initial payment made to secure it, regular premiums paid into it and the performance of the investments made in it.
How Your Policy Earns Cash Value Over Time
A portion of every premium payment goes into your policy’s cash value account. From there, how your cash value grows depends on the type of insurance policy you have.
Some policies have a fixed interest rate, which ensures the cash value grows at a steady pace. With other policies, its growth depends on the performance of investment options and market conditions.
When cash value growth is linked to market performance, there is typically a minimum rate of return, called a floor, which protects the cash value from significant declines. However, the policy likely also has a ceiling, putting a cap on the cash value’s annual growth.
Cash Value Life Insurance as an Investment
The cash value of a permanent life insurance policy can function as a tax-deferred savings or investment account. The potential returns and level of risk vary depending on the type of policy you choose.
With whole or universal life insurance, the insurance company will invest the cash value. A whole life insurance policy guarantees a fixed interest rate, insulating your cash value from financial market fluctuations. A universal policy does not provide that insulation but still guarantees a minimum rate of return and offers adjustable policy premiums.
Other policies, such as variable life insurance, allow you to choose where you invest your cash value. The cash value of a variable policy could build much more quickly than that of a whole life policy, but it could also lose value if your investments perform poorly.
Two other options are variable universal life insurance and indexed universal life insurance. The latter is less risky because the cash value is tied to an index, with the insurance company setting both a minimum and maximum rate of return. The former combines the high-risk/high-reward model of variable life insurance with the flexible premiums of universal life insurance.
How Much Does Cash Value Life Insurance Cost?
You can expect a cash value life insurance policy to cost significantly more in premiums than “pure” or “straight” life insurance products, such as mortgage life insurance or a 30-year term policy.
Exactly how much cash value life insurance costs will depend on several factors, including the type of policy you choose and the death benefit amount. Life insurance with a guaranteed payout, a guaranteed death benefit or a guaranteed rate of return will cost more because it involves less risk for the policyholder and more risk for the life insurance company. Beyond that, the higher the death benefit, the higher the premiums will be.
Because life insurance companies also consider your health and other risk factors when underwriting coverage, two people could pay noticeably different rates for identical policies. Two significant factors that will affect your rates are your age and gender. The older you are, the higher your rates will be, and women tend to secure lower rates than men because they have a longer life expectancy.
Insurance providers will also consider your medical history, lifestyle, occupation and family medical history, among other factors. Smoking and heavy drinking are among the most common lifestyle factors that will have the greatest effect on your cost. Since different companies weigh these factors differently, we recommend obtaining life insurance quotes from at least three providers so you can compare rates, as premiums can vary significantly.
How Can I Withdraw Cash Value From Life Insurance?
You can get money out of your cash value by making a partial withdrawal, taking out a loan or surrendering the policy. There may be tax consequences depending on how you get cash from your life insurance.
If you opt for partial withdrawal, your funds will generally be tax-free if they do not exceed the premiums you have paid. Any gains you withdraw from the policy are taxable upon withdrawal.
If you surrender your policy, you will pay surrender fees, and some of your funds may be subject to income tax. However, you won’t pay taxes on taking out a loan from your policy.
Is Cash Value Life Insurance Worth It?
We already mentioned that insurance companies charge higher premiums for a cash value policy. However, monthly premiums are not the only factor to consider.
Before investing in cash value life insurance, take a moment to consider its positive and negative aspects, plus your alternatives.
Benefits and Drawbacks of Cash Value Life Insurance
As a general rule, only permanent life insurance policies feature a cash value savings component. Aside from offering cash value, permanent policies provide coverage that lasts your entire life.
Securing lifetime coverage can bring greater peace of mind because you do not have to worry about outliving your policy. No matter when you die, your loved ones will receive a death benefit. You can also use permanent life insurance to guarantee an inheritance for your children or a legacy donation for a nonprofit. Plus, life insurance proceeds are rarely taxable.
Cash value policies also offer benefits while you are alive. You can use the cash value to reduce your premium payments, supplement your retirement income, pay for long-term care or cover other expenses.
Though they are tax-advantaged, policy loans and withdrawals do have one major downside: The more you take out, the less your beneficiaries will receive. It’s also worth noting that cash value will not build up quickly. It may take 10 years or longer before your policy is worth enough for you to reap the benefits. Additionally, the cash value of some policies will revert to the insurance company upon your death.
Alternatives to Cash Value Life Insurance
Despite its benefits, cash-value life insurance may not be worth it for everyone. We recommend speaking to an insurance agent and financial advisor to determine whether this policy makes sense for you.
If you are primarily concerned with supporting your children until they reach adulthood or paying off a jointly held debt, term life insurance is a more cost-effective option. A policy with a 20- or 30-year term may be sufficient to see your kids through college and will cost much less than a permanent policy. To cover an outstanding loan balance, consider mortgage or credit life insurance. The payout from these policies will go directly toward paying off the specified debt.
You can pair your term life policy with other long-term investment tools, such as a 401(k), IRA or annuity. These investments can substitute for the cash value component and, unlike a permanent life insurance policy, do not require a medical exam. Not only might you build wealth faster with these tools, but any earnings that remain after your death can be paid to a beneficiary. This is not the case for most cash value life insurance policies.
Read more: Top rated term life insurance companies
Frequently Asked Questions About Cash Value Life Insurance
In life insurance, cash value refers to the savings component included in some policies. A portion of each premium payment toward a permanent life insurance policy is deposited into a separate account and invested. As the money accrues interest, the cash value of the policy grows. Eventually, the policy owner can access the cash value by withdrawing from, surrendering or borrowing against the policy.
The cash value of a $10,000 life insurance policy depends on the type of policy, how long you have had the policy, and how well your investments have performed. The $10,000 refers to the face value of the policy, otherwise known as the death benefit, and does not represent the cash value of life insurance policy.
A $10,000 term life insurance policy has no cash value. However, a permanent life insurance policy might. Usually, the cash value steadily accumulates over the years, but the cash value of some policies can decrease if an investment performs poorly.
The death benefit may decrease when you take cash value from life insurance. The exception would be if you withdraw money in the form of a loan and repay the total amount, plus interest, before your death. In addition, it could take upwards of a decade to build enough cash value for various uses, and any cash value you haven’t withdrawn at the time of your death could revert to the insurance company, not your beneficiaries.
Cash value life insurance is a type of permanent life insurance. It builds value over time and provides lifelong coverage. Term life insurance provides coverage for a predetermined time period and does not accumulate a cash value.
Methodology: Our System for Ranking the Best Life Insurance Companies
Our goal at the MarketWatch Guides Team is to provide you with comprehensive, unbiased recommendations you can trust. To rate and rank life insurance companies, we created a thorough methodology and analyzed each company by combing through online policy information, speaking to agents via phone, reading customer reviews for insight into the typical customer experience, and reviewing third-party financial reliability scores.
After collecting this data, we scored each company in the following categories: coverage, riders, availability and ease of use and brand trust. To learn more, read our full life insurance methodology for reviewing and scoring providers.
AM Best Disclaimer
If you have feedback or questions about this article, please email the MarketWatch Guides team at editors@marketwatchguides.com.
