Cash value life insurance, also known as permanent life insurance, is a type of life insurance policy that comes with an investment component. This means that a portion of your premiums goes towards a cash value account, which grows over time on a tax-deferred basis. This cash value can be accessed during your lifetime, making it a flexible financial tool.
Understanding Cash Value
How It Works
When you pay premiums for a cash value life insurance policy, a portion of the premiums goes towards the cost of insurance (COI), which provides the death benefit to your beneficiaries when you pass away. The remaining portion goes into a cash value account, which is invested by the insurance company. The cash value grows over time due to interest, dividends, or investments, depending on the type of policy.
Types of Cash Value Life Insurance
There are several types of cash value life insurance policies:
Whole Life Insurance
This is the most traditional form of cash value life insurance. It provides a guaranteed death benefit, as well as a guaranteed rate of return on the cash value. Premiums are typically fixed and must be paid for the life of the policy.
Universal Life Insurance
This type of policy provides more flexibility. The premiums, death benefit, and cash value growth are adjustable. You can increase or decrease the premiums and death benefit as needed, and the cash value grows based on the current interest rate.
Variable Life Insurance
This policy allows you to invest the cash value in a variety of investment options, such as stocks, bonds, or mutual funds. This means that the cash value and death benefit can fluctuate based on the performance of the investments.
Variable Universal Life Insurance
This is a combination of variable and universal life insurance. It provides the flexibility of universal life insurance with the investment options of variable life insurance.
Accessing the Cash Value
Loans
You can take out a loan against the cash value of your policy. The interest rates on these loans are usually lower than those on traditional loans or credit cards. However, if the loan is not repaid, the outstanding amount will be deducted from the death benefit when you pass away.
Withdrawals
You can make withdrawals from the cash value of your policy. However, this will reduce both the cash value and the death benefit. Some policies may also charge a fee for withdrawals.
Surrender
You can surrender the policy and receive the current cash value, minus any surrender charges. However, this will terminate the policy and you will no longer have any life insurance coverage.
Tax Benefits
The growth of the cash value is tax-deferred, meaning you do not have to pay taxes on the gains as long as the money remains in the account. Additionally, loans and withdrawals are generally not subject to income taxes, unless the policy is classified as a Modified Endowment Contract (MEC).
Considerations
Costs
Cash value life insurance policies usually have higher premiums compared to term life insurance policies. This is because they provide lifetime coverage and have an investment component.
Investment Risk
The cash value growth is not guaranteed, especially for variable and variable universal life insurance policies. The cash value and death benefit can fluctuate based on the performance of the investments.
Fees and Charges
There may be various fees and charges associated with cash value life insurance policies, such as administrative fees, management fees, and surrender charges.
Conclusion
Cash value life insurance can be a valuable financial tool, providing both life insurance coverage and a way to accumulate wealth on a tax-deferred basis.
However, it is important to understand the different types of cash value life insurance, as well as the costs, risks, and potential benefits associated with each. If you’re interested in gaining a deeper understanding on cash value life insurance, we recommend delving into this article on Complete Markets.