Cash Value Life Insurance
B.A. Risk Management
Life Insurance Agent
The main purpose of buying a life insurance policy is to make sure that your family is provided with a sum of money which can replace your income in the event of your death.
In some cases, however, you might benefit more from a policy which – in addition to a death benefit – also provides you with living benefits, like cash value, which you can access during your lifetime. This type of life insurance is called cash value life insurance. It is another name for permanent life insurance, which provides a cash value component.
What is cash value life insurance?
A cash value life insurance policy covers you for your entire lifespan. It is commonly referred to as a permanent life insurance policy. Permanent life insurance has a cash value component, which you can access while you are alive, and a face value, which your family is guaranteed to receive in the event of your death.
How Does it Work?
With cash value life insurance, your coverage starts right from the moment the policy comes into force and ends only when you die. Unlike a term life policy, it does not have any expiration date. It can, however, lapse if you are unable to pay the premiums for any reason.
The premium you pay is usually divided into three portions – one portion for the death benefit amount, one portion for the cash value component, and one portion for the insurance provider’s operating costs.
The cash value of your policy increases with every premium payment you make. You can access it for your financial needs if and when needed – either by making a partial withdrawal or by getting a loan.
You are allowed to withdraw a portion of your policy’s cash value without paying any fees or penalties. The amount you withdraw, however, will get deducted from the face value of your policy.
For example, if you have a policy with a death benefit of $200,000, and if you withdraw $20,000 from the cash value portion, your policy’s death benefit gets reduced to $180,000, which is the amount your family will receive if you were to pass away.
If a partial withdrawal is not sufficient to cover your financial needs, you can get a loan from your insurance provider using your policy’s cash value as collateral.
The amount you borrow needs to be paid back in a timely manner with interest. If you pass away before repaying the loan, the total outstanding amount (the amount you borrowed plus the interest charged by the insurer) will be deducted from your policy’s death benefit.
You are not required to pay any taxes on the amount you withdraw or the loan you get from the insurer – as long as it does not exceed the amount you have paid into your policy’s cash value account up until that point. If it exceeds the amount you have paid into the cash value account, it will be treated as taxable income.
The Growth Rate of Your Policy’s Cash Value
The rate at which the cash value grows depends on the type of policy you have.
Whole Life Policy
In this type of policy, the cash value tends to grow at a fixed rate, which is guaranteed by the insurance company. So, you are assured of cash value growth year after year – regardless of the company’s performance or market conditions.
Universal Life Policy
In this type of policy, the cash value account accrues interest and grows in value as long as the policy stays in effect. There is a minimum guaranteed interest, which is credited to your account by the insurer on a regular basis irrespective of other factors.
The interest rate tends to go up if the insurance company performs well and if the market is on an upward trajectory. As a result, your policy tends to build cash value at a faster rate.
Indexed Universal Life Policy
In this type of policy, the cash value component is linked to a market index like S&P 500 or Nasdaq 100. So, the rate at which your policy accumulates cash value depends on the performance of the index.
The interesting thing to be noted here is that the money in your cash value account is not invested in the market at all.
It earns interest based on the index’s performance. If the index performs well, your policy’s cash value account tends to earn a higher rate of interest. If it performs poorly, the rate of interest tends to go down.
One of the downsides of an indexed universal life policy is that there is usually a cap on the amount of interest your cash value account can earn. So, even if the market index performs spectacularly well, you are not likely to get proportional returns on your investment.
Variable Life Policy
In this type of policy, the cash value growth rate is highly variable and entirely dependent on market conditions. The money in the cash value account is invested in a number of sub accounts. So, the cash value growth rate depends on the performance of these sub accounts.
The insurance provider usually offers you a number of equity and debt based investment accounts to choose from. Depending on your preference and risk tolerance, you can choose the sub accounts where you want your money to be invested.
The important thing to be noted here is that a variable life insurance policy does not offer a minimum guaranteed interest rate in most cases. So, if the market tanks, the cash value of your policy might get reduced drastically.
On the other hand, if the market performs well, you stand to earn a much higher return on your investment compared to what you can earn with a whole life policy or a universal life policy.
How is the Premium for a Cash Life Insurance Policy Calculated?
The premium amount of a cash life insurance policy is determined based on a variety of factors. Once set, the premium amount does not increase at any point during the coverage period for any reason.
Given below are the common factors that insurance providers take into account while calculating your policy’s premium.
The Amount of Coverage You Need
As is the case with any other type of life insurance policy, the premium of a cash value insurance policy increases proportionately with the amount of coverage you need. The larger the coverage amount, the higher the premiums.
Your age is one of the primary factors which determine your insurability, based on which your policy premium is calculated. If you are young, you will pay lesser than an older person for the exact same amount of coverage, owing to your lower mortality risk.
If you are a man, you will be charged a slightly higher rate compared to a woman of the same age for the same amount of coverage. This is because women, on average, tend to have a longer lifespan than men.
If you are free of pre-existing conditions and in good health, you will qualify for the lowest risk class, which means your premium will also be lower compared to someone who is diabetic or suffering from hypertension.
The occupational fatality rate in high-risk occupations like mining, roofing, construction, trucking, logging, and firefighting is much higher compared to most other occupations. So, if you work in any of the aforementioned occupations, you are likely to pay a higher premium compared to a teacher or an investment professional.
Family Medical History
The medical history of your family members is also a factor which is taken into account by the insurance company while calculating your policy premium.
If one or more of your family members have diabetes, heart disease, or cancer, you might be genetically predisposed to developing these problems as well. In which case, the insurer might bump up your premiums.
Smokers pay a significantly higher premium compared to someone who does not smoke, owing to your higher mortality risk.
Many insurance companies check the driving record of the applicants during the underwriting process. If you have a clean driving record, you are likely to qualify for a lower risk class compared to someone who has piled up a number of traffic violations or a DUI.
Advantages of Cash Value Life Insurance
A cash value life insurance policy covers you until your death. The policy stays in force as long as the premiums are paid regularly – irrespective of other factors. Knowing that your dependants do not have to rely on anyone for their financial needs in your absence can give you a tremendous sense of security.
One of the biggest advantages of a cash value life insurance policy is that you can use the cash value component like a savings account, which can be accessed from time to time for your financial needs. There are three ways in which you can access your policy’s cash value.
You can withdraw a portion of your policy’s built-up cash value. The amount of money you can withdraw depends on the terms and conditions of your policy.
You can take out a loan using your policy’s cash value as collateral. There are three advantages in borrowing against your policy’s cash value.
- You do not have to meet any criteria in order to qualify for the loan, since you are essentially borrowing your own money.
- The rate of interest is much lower compared to personal or business loans, which makes it easier for you to repay the loan amount in a timely manner.
- The amount you borrow from the insurer is not taxable, as long as it does not exceed the total amount of money you have paid into your policy’s cash value component.
- Cash value loans can be particularly beneficial for retirees, as they might find it difficult to qualify for a personal loan owing to their age and lack of reliable income source.
Paying Your Policy Premiums
If you have a universal or variable life policy, you can use the accumulated cash value to pay your premiums as well. This provision can be extremely beneficial for you during periods of financial instability – if you are between jobs, if you are dealing with a health problem, if your business has suffered a loss, and so on.
During these times, you can pay the premiums using the built-up cash value and make sure that your policy does not lapse.
Disadvantages of Cash Value Insurance
It is Expensive
One of the biggest downsides of cash value life insurance is that it is a lot more expensive than term life insurance.
For example, if you are a 30-year-old non-smoker, a 20-year, $250,000 term life policy is likely to cost you around $12 per month. A $250,000 whole life policy, on the other hand, is likely to cost you around $200 per month.
Understandably, not many people can afford to pay $200 per month for life insurance coverage. In fact, data from the Society of Actuaries reveals that nearly 40% of whole life policyholders tend to terminate their policies within 10 years, as a result of not being able to afford the premium payments.
Not the Best Investment
Many people tend to think of cash value life insurance as an investment. It is, however, not true at all. The returns you get on the cash value component are meager compared to what you can get if you invest the same amount of money in an index fund.
You should purchase a cash value life insurance policy only if you need lifelong coverage. It makes very little sense to treat it as an investment.
Who is Cash Value Life Insurance Meant For?
Purchasing a cash value life insurance policy might be a good idea under the following circumstances.
- If you have a disabled family member or a special needs child who is financially dependent on you.
- If you want to provide your beneficiaries with the money, they need to pay the federal and state estate taxes in the event of your death.
- If you want to leave a legacy for your loved ones.
- If you have a substantial amount of debt (mortgage, business loan, personal loan, credit cards, and so on) and want to make sure your family does not bear the brunt of it in your absence.
- If you are in need of an additional source of income – in the form your policy’s cash value component – in your retirement.
What Happens if You Surrender Your Cash Value Life Insurance Policy?
If, at any point during the coverage period, you decide that you no longer need lifelong coverage, you can surrender your policy. Once you do, the insurer will pay you the accumulated cash value.
If you surrender your policy within the first couple of years, you have to pay surrender charges, which can be quite hefty. The surrender charges tend to gradually reduce with every year. If you surrender your policy after 10 years, you do not have to pay any surrender charges.
Contact NoExam.com to Learn More
Buying a cash value life insurance policy is advisable only if you have a need for lifelong coverage.
The high costs associated with the coverage means not everyone can afford to keep up with the premium payments for a lifetime. This is something you need to keep in mind before choosing to apply for a permanent life insurance policy.
If you are not sure whether you need a term life policy or a permanent life policy or if you are in need of a permanent life policy, but not sure where to buy it from, you can get in touch with our experts at NoExam.com.
We can determine your life insurance needs, assess your financial situation, and tell you whether a permanent life policy is the right choice for you. We can also help you buy the right amount of coverage at the right price from the right insurer.