If you are considering permanent life insurance – such as whole life, universal life, or variable life insurance – you probably know that these types of policies provide both death benefits and cash value accumulation. You can use the cash value for many different needs, including your living expenses in retirement.
Pay your policy premium
Borrow from the cash value to pay large expenses, at a lower rate than banks offer
Structure an investment portfolio that maintains and accumulates wealth
Cash value life insurance is a type of permanent insurance policy consisting of a “death benefit,” which is a standard part of all life insurance policies, as well as a cash value accumulation feature. Whole life, universal life, and variable life insurance are the three primary types of cash value life insurance.
When you pay your premium, a portion of that payment is allocated towards the cash value. The life insurance company invests the money into a conservative-yield form of investment. The cash value grows over time as you continue to pay your premium and through the interest you earn.
The life insurance cash value is the amount of money you have built up through your premium and investment interest for the length of time you have owned the policy.
How Does Cash Value Life Insurance Work?
When you pay your insurance premium for a permanent life insurance policy, the money is generally allocated in three portions:
Payment for the face value of the insurance policy or death benefits, which your beneficiary or beneficiaries will receive after you pass away
Payment for the insurer’s cost for administering the policy
Payment toward the cash value, which is subsequently invested by the life insurance company
The cash value builds from a combination of each premium payment you make and the interest earned from the investments made by the life insurance company.
The cash value generally grows slowly in the first few years of the policy then experiences more significant growth later. The cash value accumulation then slows again as the policy holder ages and more of the premium is applied to the death benefits.
Life Insurance Cash Value Growth
The life insurance cash value growth is dependent on both the premium and how well the life insurance company’s investments perform. Some forms of permanent life insurance policies offer a guaranteed minimum rate of return. You’ll benefit when the investments perform well; you earn a higher return on the investments, and can be protected if the policy has a guaranteed rate of interest when economic times are slower. Additionally, some insurance companies will also pay a dividend if fewer life insurance policies are paid out in a given year.
The rate of return on the investments made by any life insurance company varies for a variety of reasons:
Some investment portfolios perform better than others
The strength of the investment market fluctuates
The account managers handling the investment portfolios have varying rates of success
The overall return rate of investment on a policy that has been in place long term can be 4.97% or higher on an annual average for the life of the policy. When you are comparing life insurance companies and policies, be sure to work with a knowledgeable independent agent who can assess how well various permanent life insurance companies have performed.
Life Insurance Cash Value Tax
You might be wondering if and when you have to pay income tax on the cash value portion of your policy. This is how the tax situation works.
Whole life non-participating policy and universal life insurance policy: As long as cash value continues to grow in an active policy, the cash value is not taxable until one of the following occurs:
You cancel or “surrender” the policy
You transfer the life insurance policy, such as when you assign or sell the policy
The policy is no longer considered a life insurance contract by the IRS
Participating whole life policy: The same applies to these policies with above described conditions, but there is a slight difference when it comes to the payment of the dividends on a “participating” whole life insurance policy. In a participating whole life policy, dividends are paid out to the policy holder and are considered to be a “return of premium.” The policy holder has four choices to choose from in how to use the dividends:
Buy more coverage
Use the dividends to reduce the future amount of your premiums
Reinvest the dividends
Receive the dividends in cash
These dividends are not taxable until or unless the dividends you receive exceed the total amount of premiums paid on your particular policy. Any dividends you receive that exceed the total amount of premiums paid on your policy are considered taxable. The excess dividends will be taxed regardless of how you use them.
Cash Value vs. Surrender Value
The cash value and the cash surrender value are inherently the same. The difference between the cash and the surrender value is that if you surrender your policy (for example, if you choose to cancel and cash out the life insurance policy), you will receive the cash value that has accumulated less any applicable surrender charges; these charges are pre-determined by the life insurance company, and are stipulated in your policy contract.
Note that there is a “surrender period,” which is the period of time that a policyholder must wait before it is possible to receive the cash value of the policy upon canceling. If the policyholder cancels the policy before the end of the surrender period, it is not likely the policyholder will receive any amount of the cash value because these costs are incurred by the insurance company to set up the policy.
Borrowing Against Your Life Insurance Cash Value
After the surrender period ends, you can typically take out a loan against a portion of the available cash value. Note that you should only do so for an express purpose, and that there are several things to consider:
This loan can be taken out without having to pay taxes on it
You are not required to repay this loan back to the insurance company
The insurance company will charge the interest rate on the outstanding loan
Both the interest the company is charging for the loan and the amount of cash value you borrowed will be deducted off the death benefits if you die while the policy is still in force, unless you have repaid the loan
A life insurance cash value policy can help you build up a substantial savings over time and can be especially advantageous if you aren’t very investment savvy or have difficulty saving money for your retirement.
There are many different versions of these types of policies and they vary in how they are structured. You are best advised to contact a local independent agent in the Trusted Choice network who can provide unbiased information about cash value life insurance policies versus term life insurance policies. One of these agents, right in your area, can help to evaluate your financial needs and goals and answer your questions about various life insurance options.
Find an agent today to learn more about permanent life insurance cash value policies and get the coverage you need.