When you add a cash value aspect to your life insurance policy, suddenly, the whole dynamic changes. No longer is it just a way to protect your loved ones in the event of your death; now, you can start thinking about building and accessing wealth while you’re still alive. But which products offer cash value life insurance? That’s what we’re here to tell you with this handy guide on all things cash value.
What is cash value life insurance?
Cash-value life insurance allows you to build wealth with your policy. You essentially pay into two pots each month for the premium when you get coverage: the death benefit and cash value. The money for the death benefit grows the amount you leave to your beneficiary after you pass away, while the cash value increases and is accessible while you’re still alive.
The following permanent life insurance policies offer a cash value aspect:
- Whole life insurance
- Universal life insurance
- Variable universal life insurance
- Indexed universal life insurance
- Guaranteed issue life insurance
The cash value element is separate from the death benefit, which means anything left in your policy reverts back to the insurer when you die. How the money builds depends on the type of policy you purchase. And the only policy that doesn’t provide cash value is term life insurance.
Cash-value life insurance plans and options
Whole life insurance
With whole life insurance, you get a fixed monthly premium and a guaranteed death benefit. The premium payments never change, which means you pay the same monthly amount throughout your life. The cash value accumulates over this time at a minimum guaranteed rate. You can also use your company dividends (if you receive them) with your whole life insurance cash value every year to build up the account faster.
Universal life insurance
Universal life insurance is more flexible than a whole life insurance policy, with many options allowing you to adjust the death benefit and reduce premiums if need be–as long as there’s enough in the cash value to cover the policy costs. As part of universal life insurance, you can opt for indexed universal life insurance (IUL) and variable universal life insurance (VUL). IUL lets you tie the cash value to an index such as the S&P 500, while VUL allows you to connect it to sub-accounts with a variety of investment types.
Guaranteed issue life insurance
Generally, a form of whole life insurance, guaranteed life insurance is available in small coverage amounts, such as $20,000. Some guaranteed life insurance policies feature a cash value element, though the potential to build wealth is lower than other options because the amount is so small in comparison. You can’t be rejected for guaranteed issue life insurance, but your beneficiaries won’t receive the full payout if you die within a few years after buying the coverage.
How can you access the cash value?
There are two primary ways to access the cash value element of permanent life insurance: by withdrawing the money directly or taking a loan out against it. If you decide to terminate the policy, you can also access the cash value you’ve built minus the penalty for leaving. This is known as a surrender charge, which is in place if you cancel within the first few years after purchasing your coverage.
Taking a loan against your policy
One of the most popular ways to withdraw the cash value involves taking out a loan against your policy, especially since this method isn’t taxed. When you pass away, the loan amount owed is paid back via the death benefit. However, because the death benefit has also accrued throughout this time, there should still be plenty to leave to your beneficiary–especially if you’ve had the policy for a long time. Using a loan for your cash value doesn’t appear on your credit report.
Withdraw the cash value
There’s also the option of withdrawing the funds directly from your policy. Just bear in mind that there can be drawbacks to this way of getting the money as it could include investment gains (referred to as “above basis”) that are taxable. Like taking out a loan, making a direct withdrawal also affects the amount of life insurance left for the death benefit.
Surrender the policy
If you surrender the policy, it means you’ve canceled the coverage, which could come with a surrender charge. Once you cancel, any cash value in the policy is given to you minus any unpaid premiums, outstanding loan balance, and potential surrender charge.
It’s not uncommon for whole life insurance policies to be classed as “participating.” This means the policy owner can obtain dividends if they’ve bought through a mutual insurance company.
A mutual insurance company doesn’t have shareholders and is essentially owned by the policyholder. That means the insurer makes more money than is needed to operate the business and pays some of it back to the policy owner via a dividend.
You can take dividends as cash, add them to your cash value, or use it to pay the premiums. They can also be used to buy “paid-up additions” to your life insurance policy, which increases the death benefit amount you leave to beneficiaries. Essentially, owning a participating policy lowers the overall costs of your life insurance.
Riders play a major role in permanent life insurance policies and offer the chance to customize your coverage. Popular riders include an accelerated death benefit, guaranteed insurability rider, and more.
Accelerated death benefit
An accelerated death benefit rider lets you unlock the death benefit before you pass away. So if you fall seriously ill or are unable to work because of injury, you can tap into the death benefit as you’ll be unable to receive regular income from your work. With an accelerated death benefit rider, you can still receive a stable income even if you’re unable to work.
Guaranteed insurability rider
Adding a guaranteed insurability rider allows you to purchase additional coverage without needing to take further medical examinations. This particular rider can come in handy if your circumstances change, such as having a child, getting married, or increasing your income. With a guaranteed insurability rider, you can also apply for extra coverage without having to provide evidence of insurability.
Some other popular life-insurance riders associated with permanent life insurance include:
- Long-term care
- Waiver of premium
- Child term
- Return of premium
While riders aren’t directly linked to the cash-value aspect of a life insurance policy, they are more common with permanent coverage and can be helpful if you wish to customize your policy so that it meets your needs.
Using cash value to pay premiums
Opting for a variable or universal life insurance policy means you can use the cash value to pay the premiums. This comes in handy if you have a large cash value with consistent returns, as you can keep coverage in place for years at little to no cost.
Nonetheless, you need to be aware of the cash value amount to ensure it doesn’t fall too far. If it does drop, you could lose your coverage–which might happen if you start using it to pay the premiums with a cash value pot that is too small or if interest rates are low.
Tax advantages of cash value life insurance
If you use a loan to withdraw the cash value, you can benefit from building your wealth tax-free. That’s because the loan is against the policy, which you own– and you can’t pay tax to yourself.
The tax-free aspect sets permanent life insurance apart from other investment accounts, as you typically need to pay tax when you grow your wealth through investments. Your beneficiaries also receive the death benefit tax-free, which is particularly helpful as most life insurance payouts are significant.
Pros and Cons of cash value life insurance
- Acts as an asset with the cash value element
- Guaranteed death benefit
- Tax-free savings
- A premium that never increases
- VUL and IUL policies allow you to grow even more wealth
- Pay dividends
- Permanent life insurance is more expensive than term options
- More risk with VUL and IUL policies
- Surrender charge if you end the policy early
What can you use the cash value for?
Once you withdraw the cash value, you can spend it on anything you like. Some people use their cash value to supplement their retirement income, making sure they have a nice little nest egg in retirement.
Others may use it to help out their growing children, such as paying for their college fees and education. Again, there’s the option of using it to pay off your premiums or moving it to the death benefit. And, of course, you could just use it to buy a new car, decorate your house or go on a luxury holiday.
In conclusion: Growing wealth through cash value
Cash value changes the entire way you think about life insurance. It becomes an investment account with tax-free benefits and the ability to grow and access wealth while you’re still alive. All the while, the death benefits grow so you can leave money behind to your loved ones when you pass away. Ultimately, permanent life insurance with a cash-value aspect covers you in all areas of life and can be a savvy investment to help build for your and your family’s future.