What is Cash Value Life Insurance?
The term “cash value life insurance” refers to the type of permanent life insurance that has a component of cash value savings. The policyholder can use the policy’s cash value component for various purposes, such as taking a loan, withdrawing cash, or paying the policy premium. However, a life insurance policy’s cash value component is only available until the policyholder survives. If the policyholder passes away, the beneficiaries will receive the death benefit, not the cash value component.
Explanation
In a cash value life insurance, a particular portion of the premium goes for accumulating the death benefit and covering the cost of the association. In contrast, the remaining amount 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 life insurance attracts interest income and other investment gains as it grows tax-deferred.
How does it Work?
A cash value life insurance policy usually sets the premium based on a pre-determined rate. Typically, the cash value component doesn’t accrue 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 open to the policyholder during their lifetime. If 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.
Example
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 procedure, and the accumulated cash value of $20,000. Determine the insurer’s liability in case the policyholder passes away.
If the policyholder passes away, the insurer must pay the death benefit in full, i.e., $50,000. In such a 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. Initially determined based on the policyholder’s age, the premium remains constant over the entire tenure. As such, starting such a policy at a young age is best as the premium will be lower. The policy is available for a term as short as 15 years that can go up to 65 years.
- Universal Life: This policy offers a lower, but guaranteed rate of return and 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. The policyholder is offered the option to select the accounts 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 cash value depends on the index’s performance, and the investment risk is the leading 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 remove a particular 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 insurance is through policy surrender, after which the policy becomes null and void. In all cases, a fee will be charged against the withdrawal that varies per policy guidelines and method of withdrawal.
Advantages
Some of the significant advantages are as follows:
- The beneficiary receives financial support from the death benefit after the policyholder passes away.
- Both the cash value component and the death benefit act as an asset that can be availed in times of adversity.
- Some insurers pay a dividend on the cash value component that acts as a passive income source.
- Such policies have tax benefits 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.
Disadvantages
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 than term life insurance policies with similar death benefits.
- The beneficiaries don’t receive the cash value component after the policyholder’s death.
- Usually, cash value insurance policies generate lower returns as compared to traditional investment avenues.
Conclusion
So, it can be seen that it 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.
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