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LIFE Insurance
LIFE INSURANCE INSIGHTS

Cash value life insurance guarantees a death benefit and the chance to tap into the policy while you’re alive.

You might know that life insurance is an important tool for protecting your loved ones financially once you're gone. But you might not realize that it can also be a way to build and access savings while you're still alive, too.

Cash value life insurance allows you to set aside money that earns interest, which you can withdraw, borrow against or set aside for a rainy day. However, there are many nuances to cash value life insurance, and it's important to understand how the various types of policies work before picking one. So read on to learn more if you're interested in taking out a cash value life insurance policy.

KEY TAKEAWAYS
  • Cash value life insurance are permanent life policies like whole life and universal life. 
  • Cash value policies let you borrow against the policy and pay your premium with the value.
  • Building cash value in a policy may take years before you can start tapping into the cash value. 
  • When you die with a cash value policy, the insurer absorbs the cash value unless you have a rider that includes the money as part of the policy's death benefit.

What is cash value in life insurance?

Cash value life insurance is a form of permanent life insurance that covers you for the rest of your life as opposed to term life insurance, which typically lasts 10-30 years. It's composed of two parts: the death benefit and a saving component called cash value.

"Most people are familiar with the death benefit, which is the amount paid to your beneficiaries upon your passing," says Alex Martinez, an insurance broker and co-owner of Old Oak Insurance Services.

The cash value account allows you to also set aside tax-deferred savings that earn modest returns. However, Martinez says, the death benefit on cash value life insurance typically starts off lower than for term policies, but grows over time along with the savings side.

Types of cash value life insurance policies

There are several types of cash value insurance policies, which accumulate savings in a variety of ways. Below is a closer look at the different types available.

Whole life insurance

The simplest form of permanent life insurance, whole life insurance policies allow you to set aside cash that grows at a conservative rate, which is determined by the life insurance company.

"They typically provide a slow, steady growth of 2-4% annually on your money," Martinez says.

The premium and death benefit amount stay the same throughout the policy.

Universal life insurance

Universal life insurance works similarly to whole life, except that you have more flexibility in your payments.

After an initial payment, you can choose how much you want to pay in premiums each month, as long as you meet a minimum. This can be helpful when you’re short on funds and want to pay less or have an influx of cash and want to contribute more to grow your cash value faster.

The cash value portion also grows at a rate similar to money markets.

Guaranteed universal life insurance

This type of universal life insurance has the lowest risk, since the bulk of your premium payment goes toward ensuring the death benefit. A small portion goes to the cash value part of your policy, which earns a modest rate of return.

Indexed universal life insurance

The cash invested in indexed universal life insurance policies grows at a rate that's tied to a market index, such as the S&P 500. It's possible to earn returns of 8-12% in a given year.

"There is, however, a downside," Martinez says, "which is if the corresponding market has negative returns, you will not see any growth over that timeframe."

The good news is that these policies don't allow you to lose any money. There may be a cap in place if the index overperforms in a particular year.

Variable universal life insurance

Variable universal life insurance is the riskiest option. The cash value portion is put in an account that can invest in stocks, mutual funds and other higher-risk securities. It offers the opportunity to grow your money faster, but also the possibility of the cash value and death benefit losing money if the investments underperform.

Some policies guarantee that the death benefit will remain above a certain minimum.

How does cash value life insurance work?

When you pay your premium on a cash value life insurance policy, a portion goes toward funding the death benefit (what your beneficiaries receive when you die) and another portion goes to a sort of savings or investment account that earns interest. This is money you can access while the policy is active.

"One of the reasons some people buy cash value life insurance is the potential to access cash value for other needs or as a source of supplemental retirement income," says Marjorie Ma, head of product management for AIG Life US.

Your policy continues for life as long as you keep up on your premium payments and don't end up with a negative cash value balance. Once you die, your heirs receive the death benefit and any remaining cash value gets absorbed by the insurance company (unless you add a specific rider).

Benefits of cash value life insurance

When deciding between term or permanent life insurance, many people opt for permanent due to the cash value aspect. There are a number of benefits to a cash value insurance policy, with several ways to take advantage of the money you set aside.

You can borrow money from a policy

One popular way to leverage the cash in a permanent life insurance policy is to borrow against it at a low interest rate.

"For example, if you need to pay for college tuition, or to supplement your retirement income, you can borrow from your cash value life insurance policy to fund these needs," Ma says.

Further, if you take out a loan, you won't have to pay taxes on the loan, as long as the policy is active and not considered a Modified Endowment Contract (MEC).

It's important to note that you're not actually pulling the money out of your interest-bearing account. Rather, you're borrowing from the insurance carrier with your cash value acting as collateral, allowing you to potentially earn more interest than you pay on the loan, Martinez says.

And technically, you don't actually have to pay the money back.

"When you eventually pass on, the insurance company will simply deduct your loan debt from the cash value, and your family will still receive whatever death benefits are left," Martinez says. That's assuming there is anything left, of course.

Cash value can pay your premium

You can use the cash value portion of your policy to pay your premium, but usually only if you've owned your policy for at least a year. Keep in mind that your policy will lapse if you use up the full cash value to pay your premiums.

You can withdraw money or surrender policy

You can use cash value from life insurance policies for purposes such as paying for college tuition, enjoying a much-needed vacation or for a variety of other purposes. Ma says that withdrawals are mostly federal income tax-free, as long as the amount withdrawn doesn’t exceed what you've paid into your policy. However, doing so could result in a reduced death benefit to your beneficiaries.

Ma also explains that you can surrender a policy for the amount of the cash value, "though the amount you receive in this event will be less surrender or other charges and will be typically reduced by unpaid loan balances or premiums." When you surrender your policy, your coverage gets cancelled.

It can supplement your retirement

Many retirees rely on cash value life insurance as a source of retirement income. It's generally not the primary source, since the value is usually much smaller than funds saved in a retirement account such as a 401(k) or IRA.

However, it can be a useful way to supplement income and continue earning interest while avoiding the volatility of the stock market.

You can sell your policy

Another option for cashing out your life insurance policy is selling it. You need to work with a licensed insurance settlement company to do this.

The company that buys your policy takes over the premium payments, meaning you're no longer responsible for making them. However, your heirs won’t be eligible to receive the death benefit and you won't be able to access the cash value. Rather, you receive a lump sum payment, which you may need to pay taxes on.

The amount you can receive for selling a policy depends on several factors, such as your age, health and the value of the policy.

Who should consider cash value life insurance?

Cash value life insurance is good for someone who wants a guaranteed death benefit and wants the ability to tap into a policy while still alive. Cash value policies also usually allow you to customize life insurance coverage with riders.

However, if you're looking for a more budget friendly option, term life insurance (which has no cash value) may be the way to go.

"Generally, I only advise clients to consider whole life or universal life if they have at least $500 a month to put into the policy and are looking at at least 20 years before they start taking money out," Martinez says. "This gives the policy time to accumulate a decent return and build a death benefit that makes sense for the amount paid in."

How much does cash value life insurance cost?

The cost of cash value life insurance policies can vary by product type.

"The premium for a cash value policy can depend on how long you want to pay the premium and your health and age," Ma said.

Below are the average life insurance costs per month for three types of cash value life insurance, according to data from S&P Global:

  • Whole life insurance: $52 per month
  • Universal life insurance: $55 per month
  • Variable life insurance: $40 per month

Best cash value life insurance companies

If you're shopping around for a cash value life insurance policy, there are dozens of companies to choose from. Insure.com ranked some of the best life insurance companies -- below is a look at some of the top options.

AAA Life Insurance Company: Rated best life insurance company for price and customer service, AAA offers whole life and universal life insurance.

Allstate: Allstate is one of the most-recommended insurance companies by customers at 90%. It provides whole, universal and variable universal life insurance.

MassMutual: This insurance company provides a wide range of cash value policy options, including whole, universal and variable universal life insurance. Policyholders are also owners and the company pays dividends.

Mutual of Omaha: Another mutual life insurance company, Mutual of Omaha offers both whole life and universal life insurance.

State Farm: Rated highly by customers for its web and mobile experience, State Farm offers both whole life and universal life insurance.

Using cash value to pay premiums

If you'd rather pay your premiums from your cash value than out-of-pocket, you need to contact your insurance agent and find out what your particular policy allows. Usually, insurers only allow you to pay your policy premiums using your cash value if you've owned the policy for at least a year.

However, you may need to allow your policy to accumulate value for longer than that; it's important to keep an eye on your balance because depleting your cash value will cause your policy to lapse.

When to buy a cash value life insurance policy

Cash value life insurance isn't for everybody. It's fairly expensive and offers somewhat limited investment options. The ideal candidate for a cash value policy is a high earner who has maxed out their other retirement savings accounts (such as a 401(k) or IRA) and wants an additional tax-deferred savings vehicle.

Pros and cons of cash value life insurance

Before deciding on whether to take out a cash value life insurance policy, it's important to weigh the pros and cons. Some important ones to consider include:

Pros:

  • There's a guaranteed death benefit.
  • The cash value portion grows tax-deferred.
  • It provides a low-interest and tax-free loan option.
  • Beneficiaries usually don't have to pay taxes on the death benefit (unless your estate is a certain size).

Cons:

  • Premiums are expensive compared to term life insurance.
  • You may have to qualify for a policy, which can mean undergoing a health exam.
  • It takes a long time to build up cash value.
  • The cash value isn't typically added to the death benefit.
  • Earnings are limited compared to other investment options, such as the stock market.

How to calculate cash surrender value of life insurance

If you're considering surrendering your insurance policy for a lump-sum cash payment, you might wonder how much you'll actually get. It's important to find out your cash surrender value, which is your cash value minus any surrender charges you're required to pay.

Permanent life insurance policies typically come with a surrender period, during which time the insurer will charge you a penalty for surrendering the policy. This can be 10 years or longer. However, over time, the surrender fee amount lessens until you're in the clear and won't be charged any penalty for canceling the policy.

Often, the surrender value is expressed as a percentage of the cash value. So during year one, the surrender value may be 0%, meaning you would receive none of the cash value if you canceled the policy at that time. By year five, it could be 80%, meaning you receive most of your accumulated cash value if you surrender at that time. Surrender charges are calculated using a number of personal factors and depend on the specific insurer's preferences.

Also keep in mind that a portion of that payout may be subject to income taxes. To figure out how much of your cash value is taxable, subtract the total amount you paid in premiums from the total cash value amount.

Alternatives to cash value life insurance

Cash value life insurance isn't the only way to set aside funds and earn a return. Below are a few alternatives:

Open a high-yield savings account: If you want a guaranteed rate of return and protection against losing any principal, you can put your savings into a high-yield savings account rather than an insurance policy. You can even name beneficiaries on the account so they receive the funds if you die. The downside is that it likely won't earn as high of a return on your money as with a cash value policy. Plus, there aren't any rules surrounding how the money can be withdrawn, so it's tempting to dip into it early.

Invest in the stock market: If you're looking for a way to build your wealth and retirement savings, plus maintain liquidity, you can invest your money in the stock market. The tradeoff for those higher returns, however, is higher risk of losing your principal investment, so it's not a great idea for those who are close to retirement age.

Frequently Asked Questions

Does every life insurance policy have cash value?

Not all life insurance policies come with a cash value component. Only permanent life insurance policies, which are designed to protect you over your lifetime, have a cash value. Term life insurance, which lasts for a certain period of time and then expires, does not.

What can I do with cash value in a life insurance policy?

There are several ways you can take advantage of the cash value of your life insurance policy. One option is to use the funds to pay your premium. You can also make regular withdrawals to cover living expenses, which is a popular option for retirees, though you will need to pay taxes on the gains.

You may also borrow against the accumulated value and use the funds for just about any purpose. This option doesn't require you to pay taxes, but you do need to pay interest on the borrowed amount. Finally, you can opt to leave the cash in your account and eventually use it to pay for expenses such as long-term care or pass it on to your beneficiaries.

How long does it take to build cash value in life insurance?

Cash value life insurance policies typically have a level premium, meaning that a higher percentage of your premium payments goes toward the cash value. Over time, the cash accumulation slows down and more of your payment goes toward the cost of your insurance, since it is generally more expensive to insure an older person.

The amount of time it takes to build up a cash value depends on the exact policy. Generally, there's no value within the first year. With a traditional whole life insurance policy, you can expect it to take at least 10 years to build up enough cash value to start taking advantage of it.

Can I take the cash value out of my life insurance?

One of the benefits of a cash value life insurance policy is that you can access the cash while you're alive and paying into the policy. In addition to making withdrawals or borrowing against the policy, you also have the option to surrender the policy for its current cash value, less any outstanding balance or fees.

Should you choose a life insurance policy with cash value?

Deciding whether to opt for term life insurance or permanent life insurance with a cash value comes down to several personal factors.

In general, cash value life insurance is much more expensive (anywhere from five to 15 times the cost of term life insurance with the same death benefit). However, if you’re looking for fairly low-risk ways to diversify and grow your retirement income -- and you can afford the premiums -- a cash value policy could be the right choice.

Is cash value insurance a good way to boost your retirement income?

The primary purpose of life insurance is to protect your loved ones financially once you're no longer around. That said, it doesn't hurt to have a bit of side income from a cash value policy.

In fact, a cash value life insurance policy can be a great way to supplement your retirement income, especially if you're looking to protect your wealth against market volatility while still earning modest returns.

What happens to the cash value account when you die?

If you die with a life insurance policy that currently has cash value, the insurer absorbs the cash value and your beneficiary receives the death benefit. To avoid this situation and ensure your beneficiary receives both the face value and cash value, you need to add a specific rider for it. Of course, that means paying a higher premium.

If you don't add this rider but want to ensure your loved one receives the highest payout, it's important to be sure you don't draw on your cash value too much. That's because when you die, any outstanding loan balance and fees are deducted from the death benefit before getting paid out.

Also, if you're older and have accumulated a large cash value that you don't think you'll use entirely, you can lower it in order to increase the death benefit instead.

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