Choosing the right policy among the many available options in the life insurance market can be stressful. With so many policies, add-ons, and jargon options, it may be difficult to choose which is best for your specific needs and budget. Cash value life insurance is just one of the terms you need to educate yourself about.
Simply put, the cash value of a life insurance policy can be withdrawn by the policyholder and used like a savings account or investment. However, while cash-value life insurance may seem like a good idea at the time, it isn’t always the best option, and not all insurance policies have this component.
Read on to learn the basics of cash value life insurance and whether this is your smartest choice.
There is an additional cash-value portion in cash-value life insurance, which is why it is often called permanent life insurance. In most cases, you can borrow against this cash value before the insurance expires to cover things like final costs. The following life insurance policies carry a cash value component:
- Whole life insurance
- Universal life insurance
- Variable universal life insurance
- Indexed universal life insurance
Term life insurance does not have a cash value component.
Where does the cash value of my life insurance go?
When you make premium payments on a life insurance policy, the cash value increases. The premium you pay will be partially allocated toward the cash value, the death benefit, and the expense charges.
Every permanent life insurance policy with a cash-value savings component will have a portion of your premium payments invested in a cash-value savings account, earning income over time. Unlike universal life plans, whose cash value growth is more subject to market fluctuations, whole-life policies offer a predetermined interest rate on cash value accumulation (given a guaranteed minimum interest rate).
The flexibility of your cash value depends on the specifics of your life insurance policy. When the cash value of whole life insurance reaches the death benefit, the policy expires immediately, and the beneficiary receives the whole death benefit. With universal life, you can accumulate a cash value that could one day be used to cover the cost of your premiums, resulting in “zero-cost” insurance. In both cases, the policy’s cash value can be borrowed against once it reaches a specified threshold.
It’s important to remember that the cash value component in life insurance policies is to help you while you’re alive. This includes allowing you to take out a loan and maybe lowering your premium payments. Unless the terms of your policy permit the cash surrender value to be included in the death benefit, your death benefit will not change regardless of how much money you have in the bank.
After making premium payments for a set amount of time, you’ll have access to the cash value in your policy, which you can use in any way you choose. You can get a loan, cover the annual premium, or supplement your retirement income with cash value.
To avoid paying taxes on the interest, you earn while repaying a loan taken out with the cash worth; you should invest it elsewhere. You won’t have to pay taxes on your withdrawals if they are below the amount of your cash worth that is premium-related. Gains on investments are subject to taxation, so if your withdrawal exceeds your investment amount, you will have to pay taxes on the excess.
Note: Loans taken out against life insurance policies might diminish the payout to beneficiaries if they are not repaid.
When should I get a cash value policy?
Compared to term life insurance, the premiums for cash-value plans might be astronomically higher. But if you get a cash value policy and hold on to it for 15 or 30 years, you may have a considerable pension pot, nest egg, savings account, or whatever you want to call it. If you’re under 35 and in good health, investing in a cash value policy can help you build a sizable savings cushion.
It’s always good to talk to an experienced life insurance agent to better understand which policy works for your situation. Our Franklin Life and Annuity team is more than happy to offer their guidance and support. We’ll ensure you make the right decision for yourself and your loved ones, whether that’s final expense insurance or a life insurance policy.
Get in touch with us to learn more.