People are often confused when they first hear the phrase “what is cash value life insurance” because it seems complicated. They know it involves both death benefits for loved ones and a savings component. But how does this type of life insurance work? Let’s break it down in simple terms so you can decide if it fits your financial goals. In this post, you’ll learn exactly what cash value life insurance is.
Table Of Contents:
- What Makes Cash Value Life Insurance Different?
- Options for Your Cash Value
- Types of Cash Value Life Insurance
- Tax Advantages, But Not a Free Pass.
- Is Cash Value Life Insurance Right For You?
- Conclusion
- FAQs about what is cash value life insurance
- Conclusion
What Makes Cash Value Life Insurance Different?
Unlike term life insurance, which is purely for a set period, cash value life insurance is a long-term commitment – think ‘permanent’ coverage. Along with that lifelong death benefit comes the savings piece.
Think of it like this: part of each insurance policy premium you pay goes towards the death benefit. This is the part your beneficiaries receive if you pass away. However, a portion also gets directed into a separate account – your “cash value”.
Understanding Your Cash Value
This cash value is where the interesting part comes in. Over time, your cash value account grows. It can do this in a few ways, depending on the type of life insurance you have.
Some life insurance policies have guaranteed interest rates, similar to a savings account but often higher. Others are tied to the performance of market indexes, like stocks, offering the potential for greater growth but also some risk. The important point is that as this value builds, you have options.
Options for Your Cash Value
This is where cash value life insurance gets really appealing. It’s not just about providing for loved ones after death, but it gives you flexibility during your life.
1. Pay Premiums with It
As your cash value increases, you can actually use this money to cover your premium payments. This can be a great option if you’re experiencing financial hardship.
You can also use this to make the policy self-sustaining after several years. Imagine your payments essentially being ‘free’ after a while.
2. Borrow Against It
Life throws curveballs sometimes – medical bills, job loss, or even just a big opportunity that requires upfront cash. You can borrow against your cash value – essentially giving yourself a loan, backed by the policy’s savings.
The rates are often quite favorable compared to other borrowing options. Before you borrow against your cash value, it is advisable to seek help from an insurance professional who can guide you.
3. Cash Surrender or Withdrawal
This is a big one. In times of real need, or if your life situation drastically changes, you can surrender the insurance policy entirely and get the cash value paid out.
Be mindful though, this terminates the death benefit. Depending on the policy terms, you may be able to make withdrawals against the balance without full surrender. Surrendering your life insurance policy means that your beneficiaries will no longer receive a death benefit.
Types of Cash Value Life Insurance
Not all cash value life insurance is the same. Here are a few of the common types:
1. Whole Life
This is the ‘rock solid’ choice – often with guaranteed returns on the cash value. Premiums stay the same for the duration of your life.
The downside? Whole life insurance can be pricey and might not be as flexible if your circumstances change drastically.
2. Universal Life
Think of universal life insurance as ‘adjustable’ whole life. You often get some control over premium amounts and timing – useful if you anticipate financial changes down the line.
Universal life insurance policies are different from whole life insurance policies in that they often give you more flexibility.
3. Variable Universal Life
This option allows for investing within the cash value – think mutual funds or stocks. The potential for greater returns is there, but so is risk. Variable life insurance is often best suited for experienced investors comfortable managing ups and downs.
If you do not have experience in investing in the stock market or mutual funds, it is not advisable to choose a variable universal life insurance policy. Make sure to fully understand what variable universal life insurance is before choosing that as your life insurance type.
Tax Advantages, But Not a Free Pass.
Another big draw is how the cash value grows tax-deferred – similar to an IRA or 401k. This means no income tax until you take the money out. There may also be tax-free withdrawals up to a certain point.
This can be a real bonus when you think about planning for things like retirement, where cash value life insurance can help to supplement retirement income and tax savings. But this is not a scheme to evade taxes completely. Consider speaking with a tax professional about how you may be able to use your life insurance policy to supplement your income tax-free in retirement. They can also provide insight on the reporting requirements to the IRS.
There are IRS rules around excessive withdrawals and the policy lapsing – so consult a financial professional for the full scoop. Financial filings are a necessity to keep up with these rules, though it might feel like an ordeal.
A Case in Point
Imagine you bought cash value life insurance in your early 30s. For years, your premiums built up that cash account steadily.
Now you’re approaching retirement – kids are through college, and the mortgage is paid down. You might need an influx of cash but don’t want to touch your tax-sheltered retirement funds just yet. Before you access your retirement accounts, it is always advisable to seek help from an insurance or financial professional.
By borrowing against your cash value – at those low rates – you access a decent chunk of money for short-term needs. Or, perhaps your kids want to buy a house and you’d like to help with the down payment? That’s possible, too. As they build financial security for their own family, you may see that you no longer require a substantial death benefit. Thus, you might choose to surrender the insurance policy and receive the cash value.
Is Cash Value Life Insurance Right For You?
There’s no simple “yes” or “no” here. If you primarily need a huge death benefit over a specific period (mortgage protection, income replacement for dependents, etc.), then a basic term life insurance might be enough.
You also must ensure that coverage remains active when needed. For that period of coverage, life insurance helps to protect those who depend on you financially.
But cash value shines when: a) you want that long-term coverage for as long as you live; b) tax-deferred savings appeals to you; and c) you value having access to funds if your life takes an unexpected turn.
Conclusion
If you’re researching options and thinking, “What is cash value life insurance really about?” remember it’s a hybrid: long-term coverage plus potential savings, but with some complexities. While tempting, consider carefully if what cash value life insurance can align with your personal circumstances and seek out an insurance professional to guide your decision.
FAQs about what is cash value life insurance
How does cash value life insurance work?
Cash value life insurance policies have a death benefit for your beneficiaries and a savings component. Part of your premium pays for coverage, and the rest grows within this cash value account.
You can often use it for things like paying premiums, borrowing against it, or in certain cases, getting a full cash surrender.
What is the cash value of a $100,000 life insurance policy?
Trick question. There’s no set amount. Cash value growth depends on the type of policy (whole, universal, etc.), the interest rates offered, how long you’ve had the policy, and whether you’ve used any of the cash value previously.
What is the disadvantage of cash value life insurance?
Primarily, cost. These life policies have higher premiums than term life, and you need to maintain those payments to keep the policy and the cash value going.
Some cash value growth can also be very slow, especially in the early years. Also, complex tax rules apply. This means consulting a financial professional is key.
What is the cash value of a $25,000 life insurance policy?
Same as above. The life insurance policy’s death benefit doesn’t directly determine cash value. Growth is based on premium amounts paid, interest earned (or market performance in some cases), policy fees, and the duration you’ve held the policy.
