Whole Life Insurance Cash Value Explained – Cash value life insurance is a form of permanent life insurance – lasting for life – that has a cash value savings component. The policyholder can use the cash value for many purposes, including borrowing or withdrawing cash from it, or using it to pay policy premiums.
Cash value insurance is permanent life insurance because it provides coverage for the life of the policy holder. Usually, cash value life insurance has higher premiums than term life insurance because of the cash value element. A portion of each premium payment is set aside for insurance costs, and the remainder is deposited into a cash account.
Whole Life Insurance Cash Value Explained
The cash value of life insurance earns interest, and taxes are deferred on accumulated earnings. As premiums are paid and interest accrues, the cash value increases over time. As the cash value of life insurance increases, the insurance company’s risk decreases, as the accumulated cash value offsets part of the insurer’s liability.
What Is Cash Value Life Insurance?
Consider a policy with a $25,000 death benefit. The policy has no outstanding loans or prior cash withdrawals and an accumulated cash value of $5,000. Upon the policyholder’s death, the insurance company pays the full death benefit of $25,000. The money accumulated in cash value becomes the property of the insurer.
Since the cash value is $5,000, the actual liability cost to the life insurance company is $20,000 ($25,000 – $5,000).
Whole life insurance, variable life insurance, and universal life insurance are examples of cash value life insurance. Term insurance is not cash value insurance.
The cash value component serves as a lifetime benefit for policyholders from which they can access funds. There are several ways to do this.
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For most policies, partial surrenders or withdrawals are allowed, although they reduce the death benefit. Some policies allow unlimited withdrawals, while others limit how many withdrawals can be taken during a period or calendar year. Some policies limit the amounts available for removal (eg, $500 maximum).
If you withdraw more than the amount you paid into the cash value, that portion will be taxed as ordinary income.
Most cash value life insurance arrangements allow cash value policy loans. As with any other loan, the issuer will charge interest on the outstanding principal. The outstanding loan amount will reduce the death benefit dollar for dollar in the event of the insured’s death before the loan is fully repaid.
Cash value can also be used to pay policy premiums. If there is sufficient balance, the insured can stop paying premiums out of pocket and have the cash account cover the payment.
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Permanent life insurance policyholders have the option to borrow based on the accumulated cash value, which comes from regular premium payments plus all interest and dividends accrued on the policy.
Those looking to build a nest egg over a time horizon of several decades may want to consider cash value life insurance as a savings option, along with a retirement plan such as an IRA or 401(k). Keep in mind that cash values often don’t begin to accrue until two to five years have passed. And you may have to wait a few years to access the cash value or pay a penalty.
Yes, cash policy premiums are usually higher than regular life insurance because a portion of your payment goes toward savings.
If you make withdrawals from the cash value of the life insurance policy, the death benefit will be reduced. If you withdraw everything, the policy ends.
Cashing Out Of Life Insurance
Life insurance withdrawals have a tax advantage in that the IRS considers your withdrawals to be a return of the premiums you paid for the policy. So you can withdraw that amount of money without paying tax. Any dividend or interest gains, however, would be taxed — but they wouldn’t occur until you’ve withdrawn all of your premiums.
Cash value life insurance provides a mechanism for policyholders to accumulate funds for future use. A portion of each premium is deposited into an interest-bearing savings account and the value of the cash grows tax-free over the life of the deposit. This money can be accessed for various purposes during the lifetime of the policyholder.
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By clicking “Accept all cookies”, you consent to the storage of cookies on your device to improve site navigation, analyze site usage and assist in our marketing efforts. Two of the most common types of life insurance are term and term life insurance. Whole life is a form of permanent life insurance that lasts as long as you live (assuming you pay the policy premiums). It also includes a cash account — a type of savings account that grows tax-free over time and that you can withdraw or borrow from while you’re alive. Term life insurance, on the other hand, only lasts for a certain number of years (the term) and does not realize any cash value.
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Term life insurance is perhaps the easiest to understand because it is simply insurance, with no savings or investment component. The reason you buy a term policy is because of the promise of a death benefit to your beneficiary if you die while it is in effect. For many people, it’s a way to make sure their minor children are taken care of and their mortgage is paid after they die.
As the name suggests, this basic form of insurance is only good for a certain period of time, be it five, 20 or 30 years. After that, the policy expires.
Because term policies offer basic coverage with a limited duration, they tend to be the cheapest type of life insurance, often by a large margin. If all you’re looking for in a life insurance policy is the ability to protect your family when you die, then term insurance is probably best.
Because term policies are usually more affordable and can last until your child reaches adulthood, term insurance can be an especially good option for single parents who want a safety net for their child if they die.
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According to figures compiled by more than 30 insurers, the average monthly premium for a 42-year-old man in excellent health who applies for a 30-year policy with a $250,000 death benefit is $33.24 a month. For a comparable female applicant, it’s $27.31.
Various factors will change the price, of course. For example, a higher death benefit or a longer coverage period will certainly increase premiums. Also, most policies require a medical exam, so any health complications could raise your rates above the norm as well.
Since the insurance eventually expires, you can make sure you spent all that money for nothing but peace of mind. Also, you can’t use your term insurance investment to build wealth or save on taxes like you can with other types of insurance.
Whole life is a form of permanent life insurance, which differs from term insurance in two key ways:
Ways To Capture The Cash Value In Life Insurance
Most whole life policies are “level premium,” meaning you pay the same monthly rate for the life of the policy. Those premiums are divided in two ways. A portion of your payment goes toward the insurance component, while another portion helps build your cash value, which grows over time.
Many providers offer a guaranteed interest rate, although some companies sell participating policies, which pay non-guaranteed dividends that can increase your total return.
Typically, your cash value doesn’t accumulate until two to five years after coverage begins. However, when this happens, you can borrow or withdraw the amount of your cash value, which grows on a tax-deferred basis. For example, you may want to take out a loan to pay for expenses such as school fees or repairs to your home.
The advantages of the loans compared to other types of loans are that there is no credit check and the interest rate can be lower. You also don’t have to pay off the loan, but it will reduce your death benefit. Withdrawals are generally tax-free as long as you don’t take out more than you paid into the policy.
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The ability to withdraw or borrow from a whole life insurance policy makes it a much more flexible financial tool than a term policy.
Unfortunately, death benefit and cash value are not completely separate characteristics. If you take out a loan from your policy, then your death benefit will be reduced by a corresponding amount if you don’t repay it. For example, if you take out a $50,000 loan, your beneficiaries will receive $50,000 less, plus any accrued interest, if the loan is still outstanding.
The main disadvantage of whole life insurance is that it is more expensive than a term policy – quite a bit. Permanent policies cost an average of five to 15 times more than term cover with the same death benefit. For many consumers, a relatively high price