Cash Value Life Insurance: Is It Worth It?

Cash value life insurance is a type of permanent life insurance policy. Unlike term life, which only has a death benefit, a permanent life insurance policy has a death benefit and a cash value.

Cash value life insurance is just another name for permanent life insurance or whole life insurance. The names are often used interchangeably.

It's strange how the life insurance industry has so many different names for the same product. But now you know.

How Cash Value Life Insurance Works

Permanent life insurance provides a death benefit that is paid to your beneficiaries when you die. It also provides cash value that you can tap into after having the policy for several years. The cash value can be used to pay premiums, borrowed against, or used to increase your death benefit.

There are many different types of permanent life insurance policies, also known as cash value life insurance. The main ones are whole life insurance and universal life insurance.

A whole life’s cash value differs from a universal life policy in terms of how the interest is credited to the policy.

Whole life credits interest based on dividends declared by the insurance company. If the insurance company declares a 5% dividend for the year, then your policy is credited with 5%. Whole life generally has a minimum interest rate return where your cash value is invested conservatively.

With an indexed universal life policy, the insurance company credits interest based on the performance of a stock market index, typically the S&P 500. At the end of the year, a policyholder receives the same return as the index – positive or negative.

There is sometimes an upside and downside cap on returns. Best to always double check with your insurance provider.

The advantage of an indexed universal life policy is that you may be able to get a better return over time if the index performs well. Since 1926, the S&P 500 has returned 8% a year or 10% a year including dividends. Of course, past performance is not indication of future performance.

Don't Wait Until It's Too Late

My regret was not getting an indexed universal life policy in 2009. If I did, I would have build a lot more wealth since the S&P 500 has performed very well since.

At the same time, investing in the S&P 500 entails more risk than investing in a basket of low-risk bonds that usually comes with investing in a whole life policy.

How To Use The Cash Value

When you get a permanent life insurance policy you pay a premium. The premium goes towards covering your death benefit and to building up the cash value. The cash value is invested in a variety of ways, depending on the type of permanent life insurance policy you get.

With whole life insurance policies, you pay a fixed monthly or annual premium. With indexed universal life policies, the premiums are more flexible, which is why some opt for this type of permanent life insuranc epolicy. have fixed premiums.

In an indexed universal life policy, you can pay a lower premium or skip premiums altogether if there's enough cash value in the policy. That's a nice option to have when you get older and cash flow is more tight.

As your cash value grows, you can use it in several ways:

  • Supplement your retirement income
  • Pay down debt or cover certain expenses. 
  • Pay your premiums
  • Boost your death benefit
  • Borrow against it

Another important thing to remember about cash value life insurance is that you can't surrender the policy in the initial years or you'll lose value.

You can have $100,000 of cash value, but that doesn't mean that's the amount you'll walk away with if you were to surrender or cancel that policy. The surrender value in the first few years of the policy is going to be less than the cash value.

Let me share three examples of how the cash value can be used.

Example 1: Using cash value to offset premium payments

Year of policyAgePremium paid out of pocketCash surrender valueDeath benefit

* For these years the premium payment is assumed to be completely or partially paid through the use of dividend values. A change in dividends could result in the resumption of premium payments.
** This year represents the insured's life expectancy.

Example 2: Paying all premiums out of pocket

Year of policyAgePremium paid out of pocketCash surrender valueDeath benefit

** This year represents the insured's life expectancy. Source: New York Life Insurance Co.

Example #3: cash value just builds over time

Here is another quote I found that highlights a $500,000 universal life insurance policy for a 42-year-old, preferred-plus male. The current interest rate is 4.25% with a minimum interest rate of 2%. His monthly premium remains fixed at $830.

This is an Option B universal life insurance policy, which means that the cash value gets added to the death benefit and paid 100% to the beneficiaries. The other option, Option A, is where the cash value goes back to the insurance company if not used. As a result, going with Option B is more expensive.

It's really nice to have a permanent life insurance policy where the cash value grows in a conservative manner, tax-deferred. Review your policy to see what the coverage entails. The rider would have caused a higher premium. 

Universal Life Insurance Policy

Who Should Get Cash Value Life Insurance?

Cash value life insurance is much more expensive than term life insurance due to the building up of the cash value.

Therefore, the majority of people will get term life insurance to save on cost as it is more affordable life insurance. Any savings they have from the term life policy can be invested. But as we know with renters versus homeowners, there's a reason why the average homeowner has a net worth far greater than a renter's net worth. People tend not to invest the difference.

Here are the people who should get a cash value life insurance policy:

  • People who don't have the discipline to buy term life and invest thee rest
  • Those with strong cash flow and high income
  • People who have a pre-existing condition
  • Folks who have lifelong dependents due to some illness
  • People who already max out their tax-advantageous accounts and want another way to build wealth.
  • Those who are fortunate enough to build a high level of net worth
  • People who want life insurance for their entire lives and not have to think about re-upping

Cash Value vs Term Life Cost And Investment Differential

Below is an interesting theoretical example that shows what the invested return with be assuming a 4.6% rate of return. Notice the premium difference between whole life and term life. It's a big difference.

The problem with the below example is that most people won't invest 100% of the difference. And even if they did, the returns are not a guarantee.

Year of policyWhole life: PremiumWhole life: Cash surrender valueWhole life: Annual rate of returnTerm life: PremiumInvested difference: Side fund at year end at 4.6%

Source: James Hunt, Consumer Federation of America

Pros Of Cash Value Life Insurance

Although most people are recommended to get term life insurance, here are some pros for getting cash value life insurance:

  • Guaranteed death benefit so you never have to worry so long as the premiums are being paid
  • Tax-deferred growth on the cash value
  • Cash value life insurance offers liquidity since you're able to access your policy without a penalty and taxes before age 59.5 — unlike a 401(k), IRA or Roth
  • Tax-free benefits to beneficiaries if your estate is below the estate tax threshold – currently $11.58 million per person in 2020
  • Tax-free loans taken out against the policy.

Cons of Cash Value Life Insurance

  • The main con is the much higher premiums. Cash value life is much more expensive than term life because you have to fund the cash value along with the death benefit.
  • You will likely have to take a health exam to qualify. A health exam includes drawing blood.
  • The insurance company will get to keep all the unused cash value if you die. Therefore, make sure you use it all or you get an Option B plan where the cash value is guaranteed to go to your beneficiaries.

Cash Value Life Insurance

Cash value life insurance is a type of permanent life insurance that is great for some people who can afford the higher premiums. Before you get cash value life insurance, go over your finances and determine whether you require life insurance for your entire life.

Also spend some time familiarizing yourself with all the different life insurance options out there to make the most informed decision possible.

Cash value life insurance is another way to tax-efficiently build wealth over the long run. If you like the combination of building wealth while ensuring your life, then a cash value life insurance policy is the way to go.

The most efficient way to get competitive cash value and term life insurance quotes is to check online with PolicyGenius, the #1 life insurance marketplace where qualified lenders compete for your business.

It's much easier to apply on PolicyGenius than go to each carrier one-by-one to get a quote. I've known the founders for years and they have truly built a fantastic resource for individuals and small business owners.

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