Cash value life insurance

Permanent life insurance policies are investment products that accumulate cash value, so they’re also known as “cash value policies.” These policies offer lifelong coverage and flexible savings options, but they’re expensive — and they can be risky.

What is cash value life insurance?

Cash value life insurance is coverage that lasts your entire life, and has an investment component that builds cash value over time.

Once you’ve accumulated enough cash value, you can start to take out loans against your policy or use the money to pay for premiums, fund large expenses or save for retirement. You can also surrender your policy and collect the cash.

Does term life insurance have a cash value?

No. Term list insurance is a straightforward policy that has an expiry date and provides your beneficiaries with a payout if you die within that timeframe.

Only permanent policies — like whole, universal and variable life — have a cash value component. The cash value grows and earns interest a little differently depending on the policy you have.

How do cash value policies work?

Each time you pay your insurance premium, your payment is split between your death benefit and your policy’s cash value. The money you pay toward the cash value goes into an investment account. Over time, those dollars will grow tax-deferred and earn interest according to the type of policy you have.

Types of cash value policies

With these policies, a portion of your premiums are invested to give your policy a cash value. There are three types of life insurance policies that accumulate cash value:

• Whole life. The cash value of a whole life policy builds at a fixed rate of return.
• Universal life. The cash value is tied to a stock index, such as the S&P 500, and earns interest based on the current market rate. As such, the returns on your universal life policy may fluctuate over time.
• Variable life. When you apply for a variable life policy, you’ll be given a portfolio of stocks, bonds and mutual funds that match your risk tolerance. The cash value will then be invested into those accounts, which are managed by your insurer. Variable life offers the highest potential of return, but it’s risky – which is why it’s usually offered by prospectus only.
• Variable universal life insurance. A hybrid of universal and variable life insurance, this policy offers lifelong coverage and flexible premiums. You can invest your cash value into your chosen portfolio of investments, and adjust your coverage as needed.

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The features of cash value policies

	Whole life insurance	Variable life insurance	Universal life insurance	Variable universal life insurance
Lifelong coverage
Level premiums			Flexible premiums — the policyholder can adjust the amount and frequency of payments (according to federal tax laws)	Flexible premiums — policyholder can adjust the amount and frequency of payments (according to federal tax laws)
Guaranteed death benefit
Guaranteed cash value			Protected from loss of returns, but the cash value may be used to pay premiums	Protected from loss of returns, but the cash value may be used to pay premiums
Way cash value grows	Earns interest at a fixed rate set by the insurer	Invested into various subaccounts that are professionally managed by the insurer	Earns interest at a fixed rate set by the insurer	Invested into various subaccounts that are professionally managed by the insurer

Ask an expert: When is cash value life insurance a good idea?

Sean Polley
CEO of Polley Wealth Management

“We want to be careful here because life insurance is — first and foremost — a protection policy. It’s meant to provide some sort of protection to a loss of income or support to someone important to you in the case of an untimely death. That being said, there are some great benefits of cash value life insurance if it’s structured properly — such as tax-free withdrawals to use for education or to supplement retirement income.

How can I make the most of the cash value in my policy?

Each policy is different, so it’s important to work with an expert who can structure the policy to meet your individual objectives. There are many ways to use the cash value in a policy, with funding education or major purchases and supplementing retirement. However, it’s important to not do something that would cancel the tax-free status of your withdrawals or collapse the policy, which could leave you with taxes due on your withdrawals.

When comparing carriers, how big of a factor should your insurer’s “rate of return” be?

If we’re reviewing different rates of return in an illustration, it’s very important to understand how that estimated rate of return was determined and what the performance has been on similar policies in the past. We want to be conservative in our illustration return so that we can fully understand how the policy can realistically perform.

Then, it’s crucial to review the policy on an annual basis to make sure that it’s performing as we’d hoped. I can’t stress the importance of this enough — I’ve seen too many policyholders who failed to review their policies, only to find out several years later that the policy is not performing as they’d planned for and expected.”

What can I use the cash value of my policy for?

The cash value of your insurance policy is a flexible form of savings, and there are a few ways to take advantage of it. With your cash value, if you don’t use it during your lifetime, you lose it — your beneficiaries won’t receive it when you die.

Take out a loan

If you’ve built up enough cash value in your policy, you can take out a loan. These are the perks: There are no underwriting requirements, and insurers often offer cash value loans at more competitive rates than traditional lenders.

But borrowing against your policy’s cash value is a risky endeavor, as it could reduce your death benefit when you die. While you’re not obligated to pay back the loan, if you fail to pay back what you borrow, the amount of the loan plus interest will be deducted from the total death benefit of the policy after you pass.

Make a big purchase

If you need cash for a big purchase, you can withdraw some or all of the accumulated cash value in your policy to cover a large expense. Just like taking out a loan against your policy, this option may also reduce the size of your death benefit — which means your beneficiaries might not get as much money as you intended.

Save a retirement nest egg

Your life insurance’s cash value could help supplement your retirement income. The longer you let your cash value grow, the greater your investment later in life. But you may need to surrender your policy to access your policy’s cash value.

When you surrender your policy, you forfeit your death benefit entirely and are no longer insured. Your insurer may also charge you a surrender fee. Since surrendered cash value is also subject to income tax, this will further reduce the amount you receive when surrendering your policy.

Cover premiums

Once you’ve built up enough cash value in your policy, you may be able to use it to cover the cost of your premiums. Using the cash value of your policy to cover premiums reduces the total cash value in the policy. Should your policy’s cash value drop too low, you could stand to lose your death benefit entirely, defeating the purpose of the policy altogether.

Surrender the policy and collect the cash

If you no longer want or need life insurance, you can surrender your policy and collect the cash. But keep this in mind:

• The money you’ll receive is equal to the “cash surrender value” of your policy, which might be subject to tax.
• If you surrender your policy within ten years of taking it out, you might be charged a “surrender fee.” And if you surrender it in first two to three years, you might not get any of the cash value. Ask your insurer about their guidelines before making any moves.

Is a cash value policy worth it?

For most people, the answer is no. Cash value policies can be complicated and expensive. Some of them — like variable life — also require you to be hands-on with your policy.

However, whether it’s right for you depends on your budget, your risk tolerance and why you’re buying life insurance.

• Whole life is the least risky option because it builds at a fixed rate. That means your cash value will earn a guaranteed rate of return – even if the market dips. It’s also predictable in that your premiums and death benefit will never change.
• Universal life offers more flexibility and the freedom to adjust your premiums and coverage amounts. You just have to be comfortable with the fact that your gains may ebb and flow with market conditions.
• Variable life is best for high net-worth individuals, or those who have money stashed in other investments or savings accounts. It has the highest potential for returns and losses.

Is cash value life insurance a good investment?

From a financial standpoint, you won’t get the same return as almost any other type of investment. If you’re using life insurance purely for investment purposes, you might be better off contributing to a 401(k) or IRA. And if you want your policy to function as an emergency savings account, keep in mind that it can take 10 to 15 years to build up the cash value you need to start borrowing against your policy.

However, if you’ve already maxed out every other type of investment you qualify for and are also looking to get life insurance anyway, a cash value life insurance policy might be something to consider.

What is the expected value of my life insurance policy?

Whole life insurance becomes a cash asset over time, and you can calculate how much it will be worth in the future using the expected value formula.

The expected value is derived from the odds of an individual dying within the term, multiplied by the payout of the policy. You can think of the number as the expected return of a policy. Say someone has a 20% chance of dying within 30 years and the policy pays out $500,000. The expected return is $100,000 since you multiply $500,000 by 20%.

You can use this value to determine if a policy might be worth it for you. Say a 20-year term life insurance policy costs $1,000 a year – so $20,000 over 20 years and the expected value is $50,000. You can assume the term policy might be a worthwhile purchase since the expected return is higher than the potential cost.

Risks involved with cash value life insurance

Interest rates have a direct impact on cash value policies. When interest rates rise and fall, they have an impact on everything from new sales and dividends, to cash flow and future financial obligations to policyholders.

As such, these are the major risks of cash value policies:

• Dividends. Cash flow is usually tighter with low interest rates, meaning companies won’t pay as much in dividends. Insurance companies need to make sure they have enough money to pay their policies.
• Rate-of-return. Longer term low interest rates will mean that your own policy is earning lower interest on its cash value. This can significantly lower the value of your policy and is something you may want to review every few years.
• Product pricing. Buying a new policy in a low interest environment could save you money, as insurance companies tend to lower their prices. However, lower prices also mean lower interest rates, which can mean a lower rate-of-return.

Bottom line

Cash value life insurance helps you build your savings over the life of your policy. With accumulated cash value, you can borrow against your policy to cover large expenses, pay your premiums or build your retirement nest egg. But this type of coverage has its drawbacks, namely: expensive policy premiums and a low rate of return.

If you don’t need lifelong coverage or a policy with an investment component, explore other life insurance options.