How Do Cash Value Life Insurance Work?

Life insurance policies are the best way to create a safety net for your family members who are dependent on your income. In addition to offering, you a safe and reliable way of income replacement, life insurance policies have now tapped into areas that help you grow your investments over time.

While going through investment options, many of you might have come across the term “cash value” life insurance policies. This term is usually associated with permanent life insurance policies which we are going to discuss below.

What Is Different About Cash Value Life Insurance Policies?

A cash value life insurance policy, also known as “permanent life insurance policies,” offers cash accumulation features in addition to death benefits. They will provide you lifelong coverage along with cash value benefits from an investment account. Your premium amounts will be directed towards:

  1. A tax-sheltered investment
  2. Your actual policy
  3. Policy and change fees

The money accumulating in your investment account grows over time with interest, which is a huge upside. Although premiums for cash value insurance policies can be significantly higher compared to term life policies, they can make up for that through gains in cash value.

Further Reading: Paid Up Additions: The Magic of Cash Value Life Insurance

Cash value benefits are not part of term life insurance policies. In such cases, beneficiaries are only entitled to death benefits, which might not prove adequate for your coverage needs.

Four Types of Cash Value Life Insurance Policies

  • Whole Life Insurance: Cash value benefits will have a fixed growth rate which is decided by the insurer. Death benefits and premiums are guaranteed and won’t change over time.
  • Universal Life insurance: The interest rates on your investment account are decided by the market economy and your insurer’s performance.
  • Variable Life Insurance: Flexible death benefits and premium options. Your insurer will give you multiple options to customize your life insurance policy, including a variety of investment options.
  • Indexed Universal life insurance: These are based on performance indexes, such as S&P 500.

Further Reading: Life insurance 101: A step-by-step guide

Common ways to access Cash Value of your Life Insurance Policy

There are five common ways you can access the cash value of your life insurance policy. These include:

  1. Take out a loan. If you are able to accumulate a substantial cash value over time you can use it to take out a loan against your policy. If you are unable to pay off the loan amount or pass away, the respective loan amount will be deducted from the death benefits.
  2. Pay your premiums. After growing a sizable amount of cash benefits you can even use it to pay for your premiums. Many insurance companies would allow this upon request and you can start saving thousands of dollars on annual premiums right away.
  3. Sell your policy. If you are no longer in need of life insurance coverage then getting a settlement from your insurance company is a good way to cash out the policy. This will always be a healthier alternative to surrendering your policy.

The settlement amount will be calculated by your insurer based on the accumulated cash value but would be less than the entitled death benefit. It is important to note that you will be liable to pay for income and capital gains taxes on the settlement deal. Typically a cut would also go to your broker if you are using one to cut this deal.

  1. Surrendering your policy. If you are unable to land a good settlement deal then surrendering your policy is always an option. Upon surrendering, your insurer will pay you the net cash value of the policy.

The net cash value of your policy will be lower than the actual accumulated cash value since it includes surrender charges and other fees.

  1. Making a partial withdrawal. Many people find themselves needing less insurance coverage as their financial obligations reduce over time. In such a case making a partial withdrawal from your policy at the cost of reducing your death benefits can be a favorable option.

Trying to understand cash life insurance can be complicated. If you are interested in learning more, we can help. Please contact us today for more information.

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