What is Cash Value Life Insurance?
The term “cash value life insurance”refers tothe type of permanent life insurance that has a component of cash value savings. The cash value component of the policy can be used by the policyholder for various purposes, such as a taking a loan, withdrawingcash or paying policy premium. However, the cash value component of a life insurance policyis only available till the policyholder survives. If the policyholder passes away then the beneficiaries would only receive the death benefit and not the cash value component.
In a cash value life insurance, a certain portion of the premium goes for the accumulation of the death benefit and covering cost of association, while the remaining portion goes into the cash value. Basically, in a cash value life insurance the premium payment can be divided into three places:
- Cash value
- Cost of insurance benefits
- Policy fees and charges
The cash value component of the life insurance attracts interest income and other investment gains as it grows tax-deferred.
How does Cash Value Life Insurance Work?
In a cash value life insurance policy, the premium is usually set on the basis of a pre-determined rate. Typically, the cash value component doesn’t start accruing until 2-5 years from the policy start date. Once it starts accruing, the cash value becomes available for the policyholder as per pre-defined policy guidelines. However, the cash value is available to the policyholder during his or her lifetime. In case the policyholder passes away, the beneficiary will only be entitled to the death benefit, while the cash value component goes back to the insurance company.
Let us take a simple example to illustrate the concept of cash value life insurance. Let us assume a policy with a death benefit of $50,000. There is no outstanding loan or cash withdrawal against the policy and the accumulated cash value of $20,000. Determine the insurer’s liability in case the policyholder passes away.
If the policyholder passes away, then the insurerhas to paythe death benefit in full, i.e. $50,000. In such scenario, the cash value of $20,000 will go back to the insurer. Therefore, the actual liability of the insurance company is $30,000 (= $50,000 – $20,000).
Types of Cash Value Life Insurance
Let us now look at some of the most common policies:
- Whole Life: As the name suggests, this type of policy offers lifetime coverage for the policyholder. The premium, which is initially determined on the basis of the age of the policyholder, remains constant over the entire tenure. As such, it is best to start such a policy at a young age as the premium will be lower then.The policy is available for a term as short as 15 years that can go up to 65 years.
- Universal Life: This type of policy offers a lower but the guaranteed rate of return and it leverages deferred tax methodology. In such a policy, the insurer invests only a small portion of the premium. It should be noted that the policy stays in force as long as the policyholders the premiums regularly. It is also known as an adjustable flexible premium policy.
- Variable Life: In this type of policy the value of the death benefit and the cash value component varies as the insurance company invests the premium into several investment options like the equity market, bond market etc. As such, the insurer in this type of policy issues a prospectus that states where all the investment has been made. In fact, the policyholder is offered the option to select the accounts in which to invest the premium. Therefore, the investment risk is the primary risk in such a case.
- Universal Indexed Life: This type of policy is very similar to the universal life, but the only difference is that the cash value component is invested in various avenues like indexed funds or indices, such as S&P 500, Moody, etc. Therefore, in this case, the value of the cash value is dependent on the performance of the indices and the investment risk is the main risk.
How to Withdraw Cash Value Life Insurance
There are several ways to withdraw cash life insurance. In the case of universal life, the policyholder has the flexibility to partially withdraw a certain portion of the cash value. On the other hand, in whole life, the policyholder can take out cash value only through the way of a policy loan. The other way to withdraw cash value life insurance is through policy surrender after which the policy becomes null and void. In all cases, there will be a fee charged against the withdrawal that varies as per policy guidelines and method of withdrawal.
Some of the major advantages are as follows:
- The beneficiary receives financial support in the form of death benefit after the policyholder passes away.
- Both cash value component and the death benefit act as an asset that can be availed in times of adversity.
- Some insurers pay dividend on the cash value component that act as a source of passive income.
- There are tax benefits of such policies as the cash value grows on a tax-deferred basis.
- The cash value component of the policies can be used as collateral for taking out loans.
Some of the major disadvantages are as follows:
- The cash value component is not available for withdrawal for the initial 2-5 years.
- This type of policy is costlier as compared to term life insurance policies with similar death benefits.
- The beneficiaries don’t receive the cash value component after the death of the policyholder.
- Usually, cash value insurance policies generate lower returns as compared to traditional investment avenues.
So, it can be seen that a cash value life insurance offers multiple options for investment besides the substantial death benefit for the beneficiaries. Given the benefits and limitations, it is the policyholder’s choice to either select a cash value life insurance or a term life insurance.
This is a guide to Cash Value Life Insurance. Here we also discuss the introduction and how does cash value life insurance works? along with advantages and disadvantages. You may also have a look at the following articles to learn more –