Cash Value Life Insurance

Updated on March 11, 2024
Article byWallstreetmojo Team
Edited byAnkush Jain
Reviewed byDheeraj Vaidya, CFA, FRM

What is Cash Value Life Insurance?

A cash value life insurance provides the holder of the policy a cash value savings component where one can utilize cash for several purposes as loans, stock of cash, or payment of other premiums. Unlike typical term insurance, the benefit is received after the policyholder’s death.

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Cash value life insurance is more expensive than normal life insurance plans in terms of the premium amount. However, they provide a cash component of savings to the policyholder, who doesn’t have to lose his life. The policyholder can utilize the entire cash component while alive at the maturity period’s end. Further, the maturity amount one may utilize as loans or a source of cash.

Cash Value Life Insurance Explained

Cash value life insurance is a type of life insurance policy that not only provides a death benefit but also accumulates a cash value over time. This cash value serves as a savings or investment component within the policy, allowing policyholders to build up a pool of funds that can be accessed during the policyholder’s lifetime.

Guaranteed cash value life insurance can be treated as an investment account alongside a life insurance policy. A major chunk of the premium we pay is utilized in an investment account, and the money here multiplies in the form of interest over some time.

Generally, every policy has a maturity date, but we can withdraw the sum generated at any point by paying a minor form of penalty as fees. Also, we can utilize the cash generated 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, an investment account associated with the life insurance policy.

The cash value life insurance market includes various types, such as whole life, universal life, and variable life insurance, each with its own features and investment components. These policies provide a unique combination of life insurance protection and a savings element, making them suitable for individuals looking to secure financial coverage for their loved ones while building a cash reserve for future needs.

Types

There are typically three types of net cash value life insurance. Let us understand each of them through the detailed explanation below.

#1 – Whole Life

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

#2 – Universal Life

This type multiples itself on the deferred tax methodology and is also known as an adjustable flexible premium policy. The rate of return is less but guaranteed. The insurance company will only invest a small part of the earned premium. The cash value increases if the company earns a good profit with the invested amount. In addition, they offer a no-lapse guarantee, which means the longer we pay the premium, the longer the policy stays in force.

#3 – Variable Life

There is a variation between what we get as a death benefit and what we get as a cash component. It acts as a mutual fund where the insurance company will park the premium into several avenues like stocks, bonds, etc. Thus, the company issues the policyholder with a prospectus stating where all the money is invested.

The policyholder has the option to choose different accounts to park the premium. The risk associated here is majorly the investment risk. The cash and death benefits here change as the value of the money changes in the different accounts parked by the company.

#4 – Universal Indexed Life

It is the same as universal life: the cash value investment is made towards indexed funds 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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Examples

A cash value insurance policy offers two benefits: death benefit and cash value. Let us understand both of these benefits through the examples below. This shall give us a practical overview of the concept as well.

Example #1

Glenn has bought a $50,000 policy, paying a premium of $1,000 yearly. If he dies, his beneficiary instantly gets $50,000 on his death. But suppose he is alive and, after 30 years, wants to utilize the cash component generated from 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 take a loan against it.

Example #2

Cash value serves as a distinctive feature within permanent life insurance policies, accumulating interest and providing a readily accessible source of funds through withdrawals or loans. This feature sets permanent life insurance apart from term life insurance, where cash value is typically absent, resulting in a higher premium for policies with this added benefit. Despite the increased cost, individuals seeking an additional financial resource later in life may find the premiums worthwhile.

Accumulating over time, the net cash value life insurance in a policy offers living policyholders the flexibility to access funds for various purposes. This money can be utilized for retirement funding, covering life insurance premiums, or enhancing the policy’s death benefit to leave a more substantial legacy to beneficiaries. Additionally, there are potential tax benefits associated with withdrawals, and the policy can provide a cost-effective avenue for borrowing money. However, it’s crucial to understand that utilizing the cash value for these purposes may impact the ultimate payout to beneficiaries upon the policyholder’s death. It’s important to clarify that, in most situations, beneficiaries do not receive any portion of the cash value after the policyholder’s demise.

Is It Taxable?

While guaranteed cash value life insurance offers several tax advantages during the policyholder’s lifetime, surrendering the policy or making significant withdrawals can have tax implications. Let us understand them through the points below.

  • The cash value in a life insurance policy grows on a tax-deferred basis, meaning policyholders are not required to pay income tax on the earnings as they accumulate.
  • Policyholders can typically withdraw funds up to the amount of premiums paid without incurring income tax. These withdrawals are considered a return of premiums and are tax-free.
  • Borrowing against the cash value through policy loans is generally tax-free. Policyholders can access funds without triggering a taxable event, although interest may accrue on the loan.
  • Surrendering the policy and receiving the cash surrender value may have tax implications. Any gains above the total premiums paid may be subject to income tax.
  • The death benefit paid to beneficiaries is typically income tax-free, providing a tax advantage for beneficiaries.

Pros and Cons

Let us understand both sides of guaranteed cash value life insurance through the pros and cons below.

Pros

  • The policy remains in force as long as the premium is paid, and the policyholder receives the death benefit when they die.
  • The premium is constant irrespective of the policyholder’s age, which means the age when you take this policy is when the premium amount is decided.
  • The cash value is generated from certain parts of the premium paid and can act as an asset.
  • Certain companies even pay a dividend on cash value insurance policies.
  • The policyholder also receives tax benefits 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.

Cons

  • 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 that one can expect.
  • This type of policy is quite costly compared to term life insurance, which comes to around 6-10 times more than the death benefit we would have gotten under term life insurance.
  • Cash value and death benefit are treated differently, meaning when we die, we only get the death benefit, 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. Thus, this cannot be treated as an investment policy because other policies will generate more returns.

Cash Value Life Insurance vs Face Value

Each of these components serve a distinct purpose within the world of life insurance. Let us understand the distinctions between the two concepts through the comparative points below.

Cash Value Life Insurance

  • Cash value is a component of permanent life insurance policies that accumulate over time as policyholders pay premiums.
  • It offers living benefits, allowing policyholders to access the cash value during their lifetime for purposes like retirement funding or policy premium coverage.
  • Functions as an investment component within the policy are also made available, earning interest and potentially providing a source of tax-deferred growth.
  • These policies often have higher premiums compared to term life insurance due to the additional savings and investment features.

Face Value

  • The face value, also known as the death benefit, is the amount the beneficiaries receive upon the policyholder’s death.
  • It represents the predetermined sum assured in the policy, serving as financial protection for loved ones in the event of the policyholder’s demise.
  • The face value is typically non-negotiable and remains constant throughout the policy term in traditional life insurance.

Cash Value Life Insurance vs Term Life Insurance

Let us understand the differences between guaranteed cash value life insurance and term life insurance through the points below.

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

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