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Choosing the right type of life insurance can seem like mission impossible, with so many options and different companies out there. While term life insurance can be quite straightforward and easy to understand (and often the most affordable), another option might be a better choice for you. Cash value life insurance is one of those options.
In this article, we will discuss how cash value life insurance works, what types you can choose, and answer some frequently asked questions about cash value.
In This Article:
What Is Cash Value Life Insurance?
Cash value life insurance is a type of life insurance with a savings account attached to it. A part of your monthly or annual premiums goes towards life insurance while the other part goes to a savings account.
How Does A Cash Value Life Insurance Work?
As with any other life insurance, you will pay premiums, and your family will receive a death benefit once you are gone. Unlike term life insurance, cash value insurance does not expire and lasts for as long as you’re alive.
Not only will you have a guaranteed death benefit, but also a cash value that you can use. Funds in your savings account also earn interest, which varies from policy to policy. The amount that goes towards your cash value will differ during the course of your life. It will usually be higher in the beginning and gets lower as you get older.
Is Cash Value Life Insurance Right for You?
While the words “cash value” can make it sound like a really good deal, it is not always the best fit for everyone. It is usually much more expensive than other life insurance options, such as term life insurance. On the other hand, cash value life insurance doesn’t end after a pre-set amount of time – it lasts all your life.
There are a few different types of cash value life insurance, each carrying different risk factors, interest rates, and cash-out options. Let’s take a look at these different types and how they work.
Types of Cash Value Life Insurance
There are three main types of cash value life insurance, and each one works slightly different. They all last your whole life, and both include a life insurance product and a savings account. The funds in your savings account are invested by the insurance company to earn interest. Let’s have a look at the differences of each one of them separately:
Whole Life Insurance
Whole life insurance is the simplest type of cash value life insurance. You pay fixed premiums for your whole life with part of it going to a savings account. You will also receive a fixed return percentage that is determined in your policy and doesn’t change with time. Cash value builds up over time, so the earlier you sign for it, the more you will earn in the long run.
Universal Life Insurance
This one is a slightly more complex version of cash value life insurance. Universal life insurance allows you to control your premiums, and the death benefit itself as well. It is a good choice if you are signing up while you are young because you can change it once your situation changes for the better. The build-up of your cash value depends on the type of Universal life insurance you have – Guaranteed Universal, Variable Universal, or Indexed Universal life insurance.
Variable Life Insurance
This type of cash value life insurance allows you to decide how your savings are invested. This makes the interest rate not determined by your policy but leaving it all in your hands instead. It is also worth mentioning that the risk increases if you don’t keep an eye on your investments. Another downside of Variable life insurance is the higher fees than the ones associated with other types. If you know about investing and know how to use that knowledge, you can make a nicer return.
Disadvantages of Cash Value Life Insurance
Cash value life insurance can be an excellent option for those who want financial protection for their families with fixed premiums, but like everything else, it has some disadvantages. Before deciding on getting cash value life insurance keep this in mind:
- Cash value life insurance premiums can be significantly higher than other life insurance options. Make sure you can afford them, as you will have to pay them all your life after all. Term life insurance policies are less expensive and might be a better choice for those looking for life insurance on a tight budget.
You Can Only Use The Cash Value When You’re Alive
- Having another savings account in your name might sound like a good idea, but cash value life insurance is a bit different from other saving accounts. Should your passing be untimely, your family will only receive death benefits while the cash value you managed to grow stays with the insurance company.
You Cannot Access Your Cash Savings in the First Years
- Access to your cash is quite restricted with a cash value life insurance. During the first few years, you will not be able to access it due to all of the associated fees, commissions, and other expenses involved.
Can You Cash Out a Life Insurance Policy?
There are a few ways that allow you to cash out your earnings with cash value life insurance. Keep in mind that you will have to wait until you build up some cash value, and that might take 10 to 15 years. The ways available to cash out might depend on your policy and cash value life insurance type, but these are the two main ways to cash out a life insurance policy:
1. Partial Withdrawals
You can withdraw part of your cash value, but your death benefit will decrease unless you pay it back. It can be seen as partial surrender since you are taking a portion of your death benefit.
Different policies might have different rules on how much you can withdraw and how frequently. If the amount you withdraw is less than what you’ve paid as premiums, you will not be taxed for it. Check your cash value life insurance policy to find out how much you can withdraw.
2. Policy Surrender
Most cash value life insurance policies will allow you to surrender your policy and take out the cash value. By doing so, you will lose your life insurance and it’s death benefit. You will also most likely have to pay a surrender fee and any applicable taxes. All terms and conditions of the policy surrender can be found on the policy contract.
What Else Can You Do with a Cash Value Policy?
It might seem like it is not easy to access your savings on cash value life insurance, but there are other ways you can use it. The options available might differ from policy to policy, but these are the options that most of the policies include:
Take Out A Loan Against Your Cash Value
You can get a loan against the cash value you saved. This will decrease your death benefit until the loan is paid back in full. By taking the loan, you will also have to pay interest, which is counterintuitive since the cash value is your money in the first place.
Sell Your Policy
There are companies, usually investment companies, that can buy your cash value life insurance policy. Most of the time, it is the better option when compared to surrender, but the settlement you receive will be less than your death benefit. If the settlement you receive is higher than the sum of premiums you’ve paid, you will also be taxed.
Use Cash Value to Pay Premiums
Once you build up your cash value, you can use that cash to pay your premiums or part of them. This might be the best use of your cash value since there are usually no fees nor tax payments involved. You can look at it as an investment in your future premiums.
Is Cash Value Life Insurance A Good Investment?
Life insurance is a great investment in your loved ones and is there to replace your income once you’re gone. A benefit that this type of insurance has is that the cash value can be used to pay premiums after some years. This can help you can be sure your family is protected, and you don’t need to worry about life insurance costs when you get older.
While cash value insurance is gaining popularity, it is not the best way to invest your money. Cash value that you’ve spent all these years building will stay with an insurance company if you don’t use it in your lifetime.
As an investment, it is not that great because the return is not very high, and you might not get it at all back. You can take investment decisions with variable life insurance to make a better return, but access to your cash is very restricted when compared to other investment options available.
If you are looking for a greater return, it might be smarter to get term life insurance and invest a portion of your income elsewhere, like a Roth IRA or mutual funds.
Is Cash Value Life Insurance the Best Policy for You?
Cash value life insurance is more complicated than term life insurance. While it has some obvious benefits, it is not a good match for everyone, so caution is advised.
Picking the right life insurance can be confusing and tricky, so it is always a good idea to contact a few different insurance companies and, if possible, consult with an independent agent. Even if you decided to go with a cash value insurance policy, you need to choose which type is best suited for your needs, so do take the time to understand the available options and how these can help you or not.
Life insurance is, for the most part, taken out with the best of intentions since other people will enjoy the fruits of your labor. Make sure that the policy you take out works for everyone involved in both the short terms as well as the long term.