Cash Value Life Insurance

What is Cash Value Life Insurance?

A cash value life insurance provides the holder of the policy a cash value savings component where cash can be utilized for several purposes as loans, stock of cash, or payment of other premiums. It is unlike typical term insurance, where the benefit is only received after the death of the policyholder.

Cash-value life insurance is more expensive than normal term life insurance plans in terms of the premium amount. They provide a cash component of savings to the policyholder, which for utilizing the policyholder doesn’t have to lose his life. The entire cash component can be utilized by the policyholder while he/she is alive at the end of the maturity period. The maturity amount can be further utilized as loans or source of cash.

They are also called permanent life insurance because they cover the entire life of the policyholder, and they also demand a level of a fixed pattern of payment of premium. Only a small portion is consumed as the cost of insurance, and the rest of the entire amount is implemented as a cash component by depositing it in a cash value generation account.

Types of Cash Value Life Insurance

There are typically three types of cash value life insurance.

#1 – Whole Life

This provides coverage for entire life and is referred to as a straight life too. The premium here depends on age and remains constant even if we grow old. The best time to avail this is entering at a young age. The value of cash grows depending on the rate of interest decided by the company. They are available on a premium paying basis for a short time, too, as 15 years and can extend till 65 years. When going for a short time, the rate of the premium goes very high.

#2 – Universal Life

This type multiples itself on the deferred taxDeferred TaxDeferred Tax is the effect that occurs in a firm as a result of timing differences between the date when taxes are actually paid to tax authorities by the company and the date when such tax is accrued. Simply put, it is the difference in taxes that arises when taxes due in one of the accounting period are either not paid or overpaid.read more methodology and is also known adjustable flexible premium policy. The rate of returnRate Of ReturnRate of Return (ROR) refers to the expected return on investment (gain or loss) & it is expressed as a percentage. You can calculate this by, ROR = {(Current Investment Value – Original Investment Value)/Original Investment Value} * 100read more is less but guaranteed. The insurance company will only invest a small part of the entire premium earned. If the company earns good profit with the invested amount, the generated cash value then increases. They offer a no-lapse guarantee, which means the longer we pay the premium, the longer the policy stays in force.

#3 – Variable Life

Here there is a variation between what we get as death benefit and what we get as a cash component. It acts more of a mutual fundMutual FundA mutual fund is an investment fund that investors professionally manage by pooling money from multiple investors to initiate investment in securities individually held to provide greater diversification, long term gains and lower level of risks.read more where the insurance company will park the premium into several avenues like stocks, bonds, etc. Thus here, the company issues the policyholder with a prospectus stating where all the money has been invested.

The policyholder has the option to choose different accounts to park the premium. The risk associated here is majorly the investment riskInvestment RiskInvestment risk is the probability or uncertainty of losses rather than expected profit from investment due to a fall in the fair price of securities such as bonds, stocks, real estate. In addition, each type of investment is prone to some degree of investment or default risk.read more. Both the cash benefit and death benefit here changes as the value of the money changes in the different accounts it was parked by the company.

#4 – Universal Indexed Life

This is the same as universal life only that the cash value investment is made towards indexed fundsIndexed FundsIndex Funds is a form of mutual fund constructed to replicate and match the performance of a particular country's index like S&P, NASDAQ, etc., and helps investors take broad market exposure due to the amount invested in various stocks of the different sectors of the economy.read more or indices like Moody or S&P 500. Thus the value generated is based on the change of indices, which affects the cash value.

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How Does it Work?

• Cash Value life insurance can be more treated as an investment account alongside a life insurance policy. The premium that we pay, a major chunk of it, is utilized in an investment account, and the money here multiplies in the form of interest over a period of time.
• Generally, there is maturity date for every policy, but we can withdraw the sum generated at any point in time by paying a minor form of penalty as fees. Also, we can utilize the cash generates as collateral for loans or payment of other premiums. Partial withdrawal is also a policy for this type of insurance policy.
• The premium we pay here goes towards three components, which are as follows: a) The cost of the insurance, which is the amount which the company has to provide a death benefit. b) Fees required by the company to provide the coverage and c) Cash value, which is an investment account associated with the life insurance policy.

Example

Cash value insurance policy offers two benefits i.e., death benefit and cash value. Suppose a person has bought a $50,000 policy paying premium of $1000 yearly. If he dies, his beneficiary instant gets $50,000 on his death but suppose he is alive and after 30 years, wants to utilize the cash component generated out of the policy, which is like $10,000, he is free to take the money and use it as a source of cash for his personal needs or even taken a loan against it.

Advantages

• The policy remains in force as long as the premium is paid, and the policyholder receives the death benefit when he/she dies.
• The premium is constant irrespective of the age of the policyholder, which means the age when you take this policy is when the premium amount is decided.
• The cash value is generated out of certain parts of the premium paid and can act as an asset.
• There are certain companies that even pay a dividend on cash value insurance policies.
• The policyholder also receives tax benefitsReceives Tax BenefitsTax benefits refer to the credit that a business receives on its tax liability for complying with a norm proposed by the government. The advantage is either credited back to the company after paying its regular taxation amount or deducted when paying the tax liability in the first place.read more because the policy grows on a deferred tax system.
• The policy is quite flexible where the policyholder can surrender the policy generally after 2-3 years or go for partial withdrawal.
• We can take a loan against the amount generated or use it for paying other premiums.

Disadvantages

• The policy takes a long time to build the cash value, and suppose we surrender the policy within the first 10 years; there is hardly any cash return which one can expect.
• This type of policy is quite costly compared to term life insurance, which comes to around 6-10 times more compared to the same death benefit, which we would have got under term life insurance.
• Cash value and death benefit are treated differently, which means when we die, we only get the death benefit and not the cash value generated. The cash value can only be enjoyed when we are alive.
• Cash value insurance policies provide very low-interest rates on the sum generated, and thus this cannot be treated as an investment policy because other investment policies will generate more return.

Cash Value Life Insurance vs Term Life Insurance

• The biggest differences between the two are in terms of death benefit features and pricing. Term life insurance offers almost 4-6 times more death benefit coverage at 4-6 times lesser cost than what cash value life insurance has to offer.
• Cash value insurance though has certain investment benefit features added on it, which misses in term life, but the rate of return is pretty less where if the money was invested in other avenues like mutual fund could easily fetch a 15% return.
• Term life if you die outside the policy coverage period, the beneficiary receives nothing and also renewing term life at old age is very costly, and also sometimes the company doesn’t allow it, whereas cash value once entered is applicable lifelong provided the premiums are paid.

Conclusion

It totally depends on the choice of a policyholder which one he/she prefers to go for, whether it is a cash value or term insurance. Looking at the advantages and disadvantages, we can clearly state that cash value insurance though comparatively more expensive than term life, can be a sigh of relief for the policyholder when he is alive and is in term of the need of money but on a death benefit ground, it is a loss because the policyholder is paying more money for almost 3-4 times lesser coverage money in terms of term life insurance.

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