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Understanding Cash Value life insurance

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Cash value life insurance is a type of life insurance that has two components: a death benefit and an investment vehicle that allows you to earn interest while saving money. Cash value life insurance is different from term life insurance, which only features the death benefit, and provides no savings option.

Although cash value is more costly and not necessarily the right choice for some people, there are some investors who will benefit from it. We’ll take a closer look at what cash value life insurance is, how it works and who it is best for in this report.

What is cash value life insurance?

There are many misconceptions about life insurance, so to clarify any misunderstandings, cash value life insurance functions very differently to term insurance. Unlike term life insurance, cash value life insurance lasts as long as you live and pay your premiums. When you die, your beneficiaries will receive the death benefit, which you decided on when you applied for the policy.

But there’s more: cash value life insurance, as the name indicates, features a life insurance cash value that you can access during your life. Part of your premium goes into a savings vehicle — that may be a mutual fund, stock market index or something else — and earns a moderate rate of interest. In effect, you are getting cash for life since you can take that cash value as a loan during the life of the policy.

Cash value life insurance is vastly more expensive than term insurance, which makes it a tougher option for most young families starting out. The amount of interest you earn is rarely as high as what you might earn if you invested elsewhere, so it’s also not a great choice to serve as your primary savings/investment vehicle.

How cash value life insurance works

Applying for cash value life insurance is the same as applying for any policy: you’ll go through the underwriting process and receive a quote for your premium payments. You’ll pay those premiums monthly or annually, and once the policy is active, your heirs will receive the death benefit when you die.

Simultaneously, a portion of your premium will go into a savings account where it will be invested. Different types of cash value insurance use different types of investment vehicles. If your policy is an indexed universal life insurance policy, for example, the cash value will be invested in the S&P 500 or another stock index.

What is the cash value of a life insurance policy? That depends on how long you’ve had the policy. That cash value will grow over the years. For the first decade or so, it won’t contain much value and fees will eat up a good portion of it. But once you’ve been paying into it for 15 or 20 years, you can build up a sizable nest egg — and you can use that money while you’re still alive.

For example, let’s say your death benefit is $100,000. That part of the policy only becomes available when you die. But you’ve had the policy for 20 years now, and there is a $15,000 cash value to it. You can take that money out as a loan, use it to supplement other accounts such as a Roth IRA or 401(k), or funnel interest from that money back into paying premiums for the policy. Unfortunately, if you do not pay it back, it will be deducted from your death benefit. Your heirs don’t receive the death benefit and the cash value.

Who needs cash value life insurance

Largely because of the cost, cash value life insurance isn’t right for everyone. Term insurance provides death benefits for far less. But there are a few types of people who may want to consider it.

  • If you have a child or other loved one with special needs, who will need care throughout their lives, the long-lasting nature of a cash value policy may be a good idea, since the policy will be in force throughout your life, as long as you pay the premium.
  • Those with complex retirement portfolios who have already taken advantage of more investment-friendly options may use a cash value policy as an additional way to defer taxes while saving for the future.
  • Those with a high net-worth who are trying to minimize taxes on their estate.
  • Those who want the security of knowing that their coverage will continue for as long as they live, at a stable premium rate.

Who doesn’t need cash value life insurance

As we mentioned, most people would benefit more from a simple term insurance policy, for a couple of reasons:

  • It’s simpler and easier to understand.
  • It’s far cheaper; often as little as $20-30 per month.
  • It provides the one basic benefit of life insurance — the death benefit — without a lot of extras.

So let’s say you’re a parent with three children under the age of ten. You want to ensure that your spouse and children are well cared for if the worst should happen to you: that your funeral can be paid for, the kids can receive an education and more. After shopping around for the best rate, you purchase a term insurance policy for $500,000. If you die, they receive this amount, and can use it however they wish; and you’ve only had to pay a two-figure monthly premium.

A cash value policy for the same amount would likely have a three-figure monthly premium, which you’d still be paying long after your children were grown and financially independent. Yes, you would have the cash value of the policy, but you could probably have earned more by investing the premium payments in a higher-value investment option.

Pros and cons of cash value life insurance

Pros Cons
Cash value increases over the yearsExpensive premiums
Good for people who have loved ones with special needsPolicies are complex and harder to understand than term
Loans can be taken against cash valueCash value isn’t worth much for first decade
Tax-deferred savingsOther savings vehicles can accumulate earnings faster
Policy can be surrendered for cash value
Coverage continues throughout your life
Cash value can pay premiums

Is cash value life insurance worth it?

For most people, the answer is “probably not.” But if you are a high-net-worth individual looking for an additional savings option or someone who will need to have a policy in effect throughout their life to care for a person with special needs, you should consider a cash value policy.

It’s worth noting that by shopping around among various companies, you may find a policy that is not as expensive as others. Every insurer has their own way of assigning premiums, so it generally pays to request quotes from several companies before you purchase a policy.

The takeaway

  • Cash value life insurance stays in effect throughout your life.
  • Unlike term insurance, it includes a savings component.
  • It’s expensive, but cash value accumulates throughout the life of the policy.

Whole life or cash value life insurance is insurance that has two components: it pays out a death benefit, and it includes a savings vehicle to which a portion of your premium is allocated. How long does it take for whole life insurance to build cash value? Plan on at least a decade, which is one of the drawbacks. The other is the cost; premiums can be many times more expensive than those for term policies.

For most families, term insurance is sufficient. But a cash value policy can be worth considering if you are a high-worth individual who has exhausted other savings options, or if you are caring for a person with disabilities or special needs, who will require financial assistance throughout their life.

Mary Van Keuren

After 30 years as a writer and editor in academia, Mary now writes full-time for the insurance and finance industries. Her work has appeared on Reviews.com, TheSimpleDollar.com and Bankrate.com, as well as other consumer-focused websites.

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