Cash value is the key difference between a term life insurance policy and a whole life insurance policy.
A term life insurance policy is essentially like renting an apartment. You pay a premium (rent) to insurance your life for a specific time period. Once that time period is over, you stop paying your premium and you have to move out.
With a whole life insurance policy, it’s like buying a home with an amortizing mortgage. The premium you pay is like a mortgage that pays interest and principal. The principal is your cash value.
Let’s discuss the specifics of how cash value life insurance works, the various types, and some common questions answered.
What Is Cash Value Life Insurance?
Cash value life insurance is one of the many different type of life insurance with a savings account attached to it. A part of your monthly or annual premiums goes towards life insurance while the other part goes to a savings account.
Cash value life insurance is used by many people to not only insure their lives, but also to try and build wealth in a tax-efficient manner as well.
Many who take out cash value life insurance policies are able to contribute the maximum to their 401(k)s and plan to grow their estates to very high levels before they die. As a result, having a cash value life insurance is a tax-efficient way to further build wealth.
Another common reason to have cash value life insurance is to help with paying premiums later in life. A cash value life insurance policy usually lasts for the entire policyholder’s life.
How Cash Value Life Insurance Works
If you get a cash value life insurance policy, you will pay monthly premiums in order to insure your life from an untimely death. You decide who are the recipients of the death benefit once you’re gone.
Further, a cash value life insurance policy does not expire and lasts for your entire life. If you have a child with disability, getting a cash value life insurance policy is a good choice. ,
Not only will your beneficiaries get the death benefit, the cash value can be used to build savings that earns interest. The monthly amount that goes towards your cash value will generally be higher in the beginning and go down as you get older.
Just make sure to check with your insurance carrier whether you have the cash value life insurance where the cash value goes to the beneficiary or gets returned to the insurance company if not used up while living. Some insurance companies have Option A and Option B to designate what happens to the cash value.
The cash value that gets paid out to beneficiaries has a higher premium.
Who Is Cash Value Life Insurance Right For?
Cash value life insurance is good for:
- Wealthier individuals who plan to max out their 401(k), IRA, Roth IRA and other tax-advantageous accounts
- Planners who like to plan for the unknown
- People with dependents and debt
- People who want insurance for life
- Parents who may have disabled children who will depend on them for life, god bless their hearts
Main Types Of Cash Value Life Insurance
There are three main types of cash value life insurance policies:
Whole Life Insurance
With whole life insurance, you pay fixed premiums for your whole life with part of it going to a savings account. You will also receive a fixed return percentage that is determined in your policy and doesn’t change with time. Cash value builds up over time, so the earlier you sign for it, the more you will earn in the long run.
Whole life insurance is the most basic type of cash value life insurance policy. You are taking the minimum amount of risk with your growing cash value. Interest rates are very low for savings accounts now that the Fed has slashed rates to 0 – 0.125% and the 10-year US Treasury bond is yielding less than 1%.
It’s a great time to refinance your mortgage, but savers are not earning much income.
Universal Life Insurance
Universal life insurance gives you the flexibility to pay different premiums and alter your death benefits over time. Younger folks tend to buy universal life insurance so they can pay lower premiums while they have less money and more as they get wealthier. With whole life insurance, the premium is fixed from start to end.
The build-up of your cash value depends on the type of Universal life insurance you have – Guaranteed Universal, Variable Universal, or Indexed Universal life insurance.
Below is an example of a universal life insurance benefit growth chart for a 42-year-old male rated preferred plus. The death benefit is for $500,000 and the monthly premium is $830. The cash value goes to the beneficiary upon death and not to the insurance company. Very important!
Variable Life Insurance
Variable life insurance allows you to decide how your cash value (savings) is invested. Instead of just having your cash value build up in a low-interest savings account, you can invest the cash value in mutual funds or index funds. Of course, there is more risk involved, but there is also potentially greater return.
With variable life insurance there are slightly higher fees than other cash value life insurance policies because you pay a fee to invest your money. Fund managers aren’t going to do their jobs for free. If you are savvy about investing and believe in the long-term growth of the S&P 500, a variable life insurance policy may make sense to you.
Here’s the proper asset allocation of stocks and bonds by age. As you get older, you should reduce your stock allocation to protect your wealth. Anything can happen, like a coronavirus pandemic! Below is the conventional asset allocation model.
Negatives Of Cash Value Life Insurance
Here are the main negatives of cash value life versus term life insurance:
- Higher cost: Just like it costs more to buy a house than rent one, it costs more to have a cash value life insurance policy versus a term life insurance policy. Your premiums are higher because you have to also build the cash value. But that’s what you want anyway, so the cost really isn’t that much of a higher cost as the cash value is yours.
- Cash value can only be used when alive: Should your passing be untimely, your family will only receive death benefits while the cash value you managed to grow stays with the insurance company. Therefore, you must actively use the cash value while living.
- No access to cash value in the beginning: As you are building your cash value, you generally shouldn’t access it for the first 3-5 years. If you do, you will be wasting your money on the initial fees and startup expenses. Like your investments, you need to let them grow, unabated so they can compound over time.
How To Use The Cash Value From Your Policy
You can cash out on your cash value life insurance policy, but it will take time. Generally, you should wait at minimum 5 -10 years before you cash out anything. If you are in constant need of liquidity for some reason, which I think is overrated, then it’s best not to get a cash value life insurance policy.
If you get a cash value life insurance policy, make sure to USE the cash value before you die. Otherwise, you end up wasting that build up. Upon your death, the remaining cash value goes back to the insurance company.
Here are six popular strategies to help you make the most of the cash value in your cash value life insurance.
Boost the Death Benefit
Choose to leave a larger death benefit to your beneficiaries if you don’t plan to use the cash value for your sell. To do so, just call your life insurance company and say you’re interested in making a change. Because the company doesn’t want to lose your business, it will more than likely accept your request.
During the trade, your objective should be to completely drain the cash value and transfer the full amount over to the death benefit or the face value. For example, if you have a universal life insurance policy with a $500,000 death benefit and $200,000 in cash value, your goal is to completely empty the cash value and boost the death benefit to $700,000. That’s $200,000 more that will fall into your heirs’ hands instead of going to the life insurance company.
Pay Life Insurance Premiums
Once your cash value has grown large enough (paid up), as your insurance company to use the cash value to pay for premium payments.
Take Out a Loan
Feel free to take out a loan against your cash value at a low interest rate. If you don’t pay back the loan, your credit score and situation will be fine since it is your cash value. Just know that any money you borrow, plus interest, will be deducted from the death benefit when you die.
Make A Withdrawal
If you need more cash for some reason, you can call your insurance company up and make a withdrawal. However, know that with some whole life policies, the withdrawal may reduce the death benefit and sometimes by even greater than the amount you withdraw. Doesn’t seem fair, so you best double check before doing so.
Full Policy Surrender
You can always surrender your policy and receive the accrued cash value. But think hard before doing so. If you fully surrender, you’re relinquishing the death benefit when you surrender a life insurance policy, which means your heirs will receive nothing from the policy when you die. In most cases, you’ll also be charged surrender fees, which could greatly reduce your cash value.
Additionally, the cash you receive through the surrender is subject to income tax. If you have an outstanding loan balance against the policy, you could incur even more taxes.
Sell Your Policy
There are companies, usually investment companies, that can buy your cash value life insurance policy. Most of the time, it is the better option when compared to surrender, but the settlement you receive will be less than your death benefit. If the settlement you receive is higher than the sum of premiums you’ve paid, you will also be taxed.
Is A Cash Value Insurance Policy For You?
Cash value life insurance is a good way to insure your life for your entire life while also boosting your wealth in a tax-efficient manner.
If you have dependents, solid earning power, and plan to grow your wealth far greater than the average American, getting a cash value insurance policy is a good idea.
I personally like the Variable Life Insurance policy route because of the option to invest in stocks and other instruments. As a 25-year investment veteran who worked at a couple major investment banks, I’m comfortable taking investment risk.
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