Cash Value Life Insurance: Is It A Smart Investment?

Cash value life insurance is a type of permanent life insurance that features a cash value savings component. This means that the policyholder can use the cash value for several purposes, such as borrowing or withdrawing cash from it, or using it to pay policy premiums. The cash value component of a life insurance policy can be particularly appealing because it may be possible to access the money early. However, it's important to note that cash value life insurance is generally more expensive than term life insurance.

What is cash value life insurance?

Cash value life insurance is a form of permanent life insurance that features a cash value savings component. It lasts for the lifetime of the holder and typically has higher premiums than term life insurance. The policyholder can use the cash value for several purposes, including borrowing or withdrawing cash from it, or using it to pay policy premiums.

Cash value life insurance can provide lifelong coverage. When the insured person dies, a death benefit is paid to beneficiaries, provided that the premiums have been paid. When you make a premium payment, it is split three ways: into the policy's cash value, to the insurer's cost of providing the death benefit, and toward fees and charges.

The cash value of life insurance earns interest, and taxes are deferred on the accumulated earnings. The cash value builds over time as premiums are paid and interest accrues. This cash can be accessed for a variety of purposes during the insured's lifetime.

There are several types of cash value life insurance policies, including whole life, universal life, variable life, and indexed universal life insurance. Whole life insurance offers a fixed monthly premium, a fixed rate of growth for cash value, and a guaranteed death benefit amount. Universal life insurance allows the policyholder to adjust their premiums and coverage amount within certain limits. Variable life insurance provides greater access to investment tools, but it also involves more risk as the cash value will fluctuate with the performance of chosen investments. Indexed universal life insurance ties the cash value growth to gains and losses in a stock or bond index.

The cash value component of life insurance serves as a living benefit for policyholders, who may access funds through partial withdrawals, loans, or by surrendering the policy. However, accessing cash value before death will reduce the death benefit paid out to beneficiaries.

What types of life insurance policies build cash value?

Permanent life insurance policies such as whole life, variable life, and universal life insurance can accumulate cash value over time.

Whole life insurance is also referred to as "ordinary life" or "straight life" and provides coverage for your entire lifetime. The premium is fixed and depends on your age when you buy the policy, with the lowest premiums going to those who buy it when they're young. The cash value grows based on a fixed interest rate set each year in your policy by the company.

Universal life insurance is also referred to as "flexible premium adjustable life insurance" and features a savings element (cash value) that grows on a tax-deferred basis. The insurer invests a portion of your premiums, and the return on the investment is credited to your policy tax-deferred. Universal life insurance offers a guaranteed minimum interest rate, meaning the insurer guarantees a certain minimum return on your money.

Variable life is a permanent life insurance policy with an investment component. The company invests your cash values into separate investment accounts, such as portfolios of stocks, bonds, and other investments. The cash values and death benefit vary due to increases or decreases in the value of the separate accounts. You take on the investment risk as the policyholder.

Term life insurance does not have a cash value component.

How does your policy earn cash value over time?

How your cash value life insurance policy earns cash value over time depends on the type of permanent life insurance policy you buy.

Whole Life Insurance

Whole life insurance policies offer a fixed rate of return on the cash value, and policyholders with mutual companies may earn additional dividends. The cash value of whole life insurance can grow with potential tax savings, and the death benefit is guaranteed as long as the premiums are paid.

Indexed Universal Life Insurance

With indexed universal life insurance, the cash value growth is tied to a stock or bond index, such as the S&P 500. The cash value can decrease if the indexes fall.

Variable Universal Life Insurance

The cash value in variable universal life insurance is invested in various subaccounts of stocks, bonds or mutual funds. This type of policy offers the greatest potential returns but comes with the risk that you could lose some cash value if the investments tank.

Universal Life Insurance

Universal life insurance policies allow you to change the value of premium payments. The cash value can be used to pay for the premiums or other expenses.

Variable Life Insurance

Variable life insurance gives you greater access to investment tools, like cash value. This type of plan tends to involve more risk, as the cash value will grow or diminish depending on how the investments perform.

Indexed Life Insurance

An indexed life insurance plan has a greater relationship with the stock market, as this is what is used to determine growth. The rate of return on the cash value within the life insurance policy depends on how the chosen index performs.

Premium Payments

When you make premium payments on a cash value life insurance policy, one portion of the payment is allotted to the policy’s death benefit (based on your age, health, and other underwriting factors). Another portion covers the insurance company’s operating costs and profits. The rest of the premium payment goes toward your policy’s cash value.

Accumulation Over Time

In the early years of the policy, a higher percentage of your premium goes toward the cash value. Over time, the amount allotted to cash value decreases.

As you grow older, the cost of insuring your life gets more expensive for the life insurance company. This is reflected in the cash value accumulation, which slows down as you age and more of the premium is applied to the cost of insurance.

What can you do with the cash?

There are several ways to utilise the cash value of your life insurance policy while you are still alive. Here are some options:

Partial Withdrawals

You can make partial withdrawals from your cash value. However, if the withdrawn amount includes investment gains, often referred to as the part "above basis", that portion may be taxable as income. Additionally, making withdrawals will reduce the future life insurance payout for your beneficiaries.

Borrowing Against Cash Value

You can take out loans against the cash value of your permanent life insurance policy and use the money for any purpose, such as emergencies or supplementing retirement income. The loan amount will accrue interest until it is fully repaid. It's important to note that if you don't repay the loan, the insurer will subtract the outstanding amount from the death benefit.

Surrender the Policy for Cash

If you cancel your life insurance policy, you can receive the cash value, minus any surrender charges, outstanding loan balances, or unpaid premiums. This option will terminate your life insurance coverage.

Pay Premiums or Insurance Costs

Once you have accumulated enough cash value, you may be able to use it to cover your premium payments or the cost of insurance. This option can provide relief if you are struggling to make payments and want to keep your life insurance policy in force. Consult your insurance agent to understand the specific rules and implications.

Create an Investment Portfolio

The cash value of your life insurance policy can be used to create an investment portfolio, allowing you to maintain and accumulate wealth over time.

It's important to note that accessing the cash value of your life insurance policy may have tax implications, and it can take several years to build up enough cash value to utilise these options effectively. Be sure to carefully review the terms and conditions of your policy and consult a financial professional before making any decisions.

What are the pros and cons of cash value life insurance?

Cash value life insurance is a permanent life insurance policy that lasts for the lifetime of the holder and features a cash value savings component. The policyholder can use the cash value for many purposes, including borrowing or withdrawing cash from it, or using it to pay policy premiums. Permanent life insurance policies such as whole life and universal life can accumulate cash value over time.

Pros of Cash Value Life Insurance

• Cash value life insurance offers lifelong coverage, meaning it lasts your entire life.
• It provides flexible access to funds. Once you've built up enough cash value, you can enjoy flexible access when needed, whether you want to get a policy loan or make a withdrawal.
• It offers reasonable premiums. Although the premiums are higher than term life insurance, the cost for coverage may still fit your budget.
• Cash value life insurance offers tax advantages. Your cash value accumulates on a tax-deferred basis, so the IRS doesn't take a cut as your cash value grows.
• Your beneficiaries receive a death benefit.
• You can add riders for extra coverage.

Cons of Cash value life insurance

• Cash value life insurance costs more than term life insurance.
• Cash value can take time to build. It may take a decade or longer for your policy to be worth enough for you to reap the benefits.
• Cash value is not paid to beneficiaries in most cases. When you pass away, the cash value typically reverts to the life insurance company.
• Your policy could lapse if you borrow too much. If you take out loans or withdrawals from the policy, you must maintain a minimum cash value level, or your policy could lapse.
• Taxes may apply. If you withdraw cash value or take the surrender value and terminate the policy, you may be taxed on the portion of the money that came from interest or investment gains.

Frequently asked questions