A Simple Guide to Understanding Cash Value Life Insurance

Most people don’t like to think about their death. If you’re healthy and thriving, life insurance might not seem like such an urgent issue. After all, why would you want to pay an extra cost for something you might not think you necessarily need at the moment?

Here’s the thing: life insurance is more affordable than you think, whether you’re young or old, and at the end of the day, the cost of dying without it is too high.

With life insurance that can accumulate cash value growth, you get more than just peace of mind. You get both death benefit protection for your loved ones plus, a savings account that will grow over time and be there to help when you need it the most.

Keep reading to find out everything you need to know about cash value life insurance.

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What is Cash Value Life Insurance?

When it comes to life insurance coverage in general, there are several available types. One of the biggest decisions will be making the choice between a term life insurance policy that provides temporary coverage or a permanent life insurance policy that provides a lifetime of coverage.

In addition, you will also need to decide if you would like your life insurance to be able to accumulate cash values or have a policy that doesn’t offer cash values.

With that in mind, let’s start with the most basic question: what is cash value life insurance?

Cash value life insurance is a subset of life insurance that comes with a savings component. It is only associated with permanent types of life insurance policies which we will be discussing a little further into this article.

NOTE
Although being the most affordable of all available life insurance options, term life insurance does not accumulate any cash value growth.

The savings component of a cash value life insurance policy works a lot like an investment account. With cash value life insurance, premiums are put into the savings account portion of the life insurance policy that will grow tax-free overtime.

While it does pay out the death benefit upon your death, the cash value is not paid to the beneficiary when you die–it’s more along the lines of a living benefit.  

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How Does Cash Value Life Insurance Work?

Let’s take a closer look at how cash value life insurance works.

At the base level, cash value insurance works much like any other life insurance policy. You pay premiums to keep the policy active, and if you die within the limits of the policy’s lifespan, your beneficiaries will be paid the death benefit.

The difference is in the premiums. A cash value life insurance policy splits the premium payments in three different portions:

• The cost of the insurance, which is needed to provide the death benefit
• Fees and overhead the company needs to maintain your policy
• The cash value account within the policy

Since you add to the cash value account every time you pay your insurance premiums, your cash value grows tax-free the longer you pay. However, you won’t see much growth in the first couple of years that you own the policy since most of the initial premiums are eaten up by the cost of the insurance.

Keep in mind that the cash value is separate from the death benefit. If you die, any leftover cash value won’t be given to your beneficiaries–the insurance company will absorb it. It’s meant to be used during your lifetime as an investment account.

What’s the Difference Between Cash Value and Death Benefit?

Before we go any further, it’s important to understand the key differences between cash value and death benefit, as these are key components to your life insurance policy.

As the name implies, the death benefit is just that–it’s paid out to your named beneficiary when you die. This is the primary benefit of life insurance policies in general. They’re designed to help your family members handle costs associated with your death after you’re gone (without breaking the bank).

Take funerals, for example. The average funeral cost accounts for things like:

• Professional services fee–a fee to cover the provider’s time, usually around $2,000
• Transfer of remains to the funeral home–about $310
• Embalming and body preparation–embalming costs $695; other services like hairdressing and cosmetics run around $250
• Funeral viewing and services–viewing costs around $420, services usually cost around $495
• The gravestone–between $1,000 and $3,000

All told the average funeral can cost around $11,000+, on top of end-of-life expenses like medical bills, end-of-life care, and bills due after your death.

The death benefit helps your loved ones handle these costs without worry.

Cash value is something else entirely.

As mentioned earlier, the accumulation of cash value within a life insurance policy is more along the lines of a living benefit meant to be used while alive. It’s not disbursed after you die because it’s not intended for use after you die.

In fact, your insurance company will reabsorb any of the cash value that isn’t used by the time of your death, so your beneficiaries will never see the money. The only funds received will be the death benefit of the life insurance policy.

In simplest terms, the cash value is for your use, while the death benefit is designed for use by your beneficiaries.

What can you do with the Cash Value?

Although it may take a couple of years to start seeing cash value growth potential, a life insurance policy with this ability has several advantages.

For example, one of the largest advantages is having the option to use the cash value to make premium payments or even purchase paid-up coverage. This can become very beneficial especially in times when money might be a little tight.

Having this option can also come in handy in your senior years by having one less payment to worry about while maintaining life insurance coverage.

IMPORTANT
Being able to skip premium payments by utilizing the cash value is only an option available if you own a universal life insurance policy because of its flexibility. Whole life policies require the premium payment to be paid when due and will not allow you to use the cash value to pay future premiums.

Another advantage to cash value life insurance is having the option to obtain cash in the form of policy loans. Policy loans allow you to withdraw tax-free money from the cash value account to use however you would like. This could be for a down-payment on a house or car or unexpected expenses that may have popped up or even used for vacation expenses.

An important note about policy loans is that the loan you take does not require you to pay it back but it will require you to pay interest on the loan. In most cases, the interest rate is relatively low and often lower than taking out a personal loan from your bank. Paying the loan off will eliminate the interest completely.

If an insured passes away with an outstanding loan balance, the insurance company will deduct the balance of the loan from the death benefit.

Outside of policy loans, another way to obtain the cash values is through either partial or full surrender. A partial surrender will result in a decrease in the policy’s death benefit while a full surrender would result in total loss of your life insurance coverage.

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What Types of Life Insurance can Gain Cash Value?

We mentioned earlier that cash value policies are a subset of most permanent life insurance policies.

There are three main types of permanent life insurance that can accrue cash value growth:

• Universal Life Insurance
• Indexed Universal Life Insurance
• Whole Life Insurance Insurance

You can have more than one policy, but whether that’s advisable depends on your circumstances and your individual life insurance needs. Let’s take a look at how each one of these types of life insurance coverage works and builds cash value.

Universal Life Insurance

Universal life insurance offers permanent life insurance protection along with flexibility. It is the one type of life insurance coverage that can allow for premium payments as well as the death benefit to be adjusted as needed.

How does the cash value grow with Universal Life Insurance?

The cash value growth potential of a universal life policy is based off an interest rate declared by the life insurance company. The interest rate is generally based on the insurer’s performance in the market. The life insurance policy itself has no part in the market.

The majority of universal life insurance policies will have a guaranteed minimum interest rate that is typically around 2-4%.

Potential Concerns with Universal Life Insurance

The biggest concern with universal life insurance is that the premiums and the cash values are not guaranteed. The interest rates are often close to the minimum rate so cash values do not normally reach high amounts.

Another concern is potential rises in the cost of insurance. Should the insurance company increase your cost of insurance COI, you would possibly need to adjust what you have been paying for the coverage.

If you choose not to adjust your premium to meet the increase in the cost of insurance, the balance would be deducted out of your cash value account. When this happens it could diminish your cash value over time.

Indexed Universal Life Insurance

Indexed universal life insurance or IUL for short is a lot like universal life insurance, but with a few extra details to navigate. It is a much newer form of life insurance coverage that has only been around since 1997 but has quickly taken off with several life insurance companies offering it.

Indexed universal life insurance offers much of the same flexibility as universal life insurance but has a much greater chance in accumulating higher cash value growth. It allows for you to allocate your premiums that go towards that cash value account to either an index account or a fixed account.

How does the cash value grow with Indexed Universal Life Insurance?

Indexed universal life insurance offers two different cash accounts to choose from. The first account is a fixed interest account. This account offers generally a smaller interest rate as well as a guaranteed minimum interest rate. These rates are similar to that of a traditional universal life insurance policy.

The second cash value account is called the index account. This account can offer a much higher interest rate leading to potentially greater cash accumulation. Although the interest rate is based on the performance of the market, the cash value accumulation is in no way tied to the market.

With indexed universal life insurance, the interest rate is based on a calculated average of both gains and losses of specific indexes which result in an annual declared interest rate.

Potential Concerns with Indexed Universal Life Insurance

Indexed universal life insurance has many positives, but there are some potential concerns to consider.

One of the main concerns is that life insurance premiums and cash values are not guaranteed. Consistent bad years in the performance of the market can lead to low-interest rates. Lower interest rates will result in lower cash accumulation which can lead to the life insurance coverage requiring more premium in later policy years.

A second negative with indexed universal life insurance is the cap. Life insurance companies, unfortunately, have caps on returns. This means that if the market is having a great year or years the interest rate can be capped limiting cash growth.

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Whole Life Insurance

Finally, there’s whole life insurance, a type of life insurance that many people are familiar with. Whole life insurance is one of the oldest forms of permanent life insurance–and one of the most popular.

Whole life insurance offers a bunch of guarantees. These guarantees include a fixed premium for the life of the contract, a guaranteed death benefit that will never change as well as guaranteed cash value growth.

Some whole life insurance policies can also receive potential dividends which can further enhance the overall cash value or even be used to purchase additional death benefit coverage.

How does the cash value grow with Whole Life Insurance?

Cash value growth within a whole life insurance policy is based off a calculated formula provided by the life insurance company. Ultimately the cash value should equal the death benefit once the whole life insurance has reached maturity which is generally by age 100 or 120.

In addition to the guaranteed cash values, some whole life insurance policies have the potential of receiving dividends. Although dividends are not guaranteed, when received they can further increase the overall cash value growth.

Potential Concerns with Whole Life Insurance

Whole life insurance is a safe coverage option with hardly any risks. One drawback to this type of coverage is the high cost. Many financial experts will advise against it because they feel that the return on your money is way less than buying term and investing the difference into the market.
Another potential concern is that whole life insurance requires the premium payment to be made when due. This is not an issue with a universal life insurance policy that has enough cash value to coverage premium payment should you need to skip a few.

Excellent Non-Cash Life Insurance Options

A cash value life insurance policy has its pluses and minuses but may not be the perfect coverage option for everyone. Outside of cash value life insurance, there are a couple very popular and great options to consider.

Term Life Insurance: This type of life insurance coverage is the most affordable type of life insurance coverage. It provides life insurance coverage at a fixed price based on a contract length of either 10, 15, 20, 25, or 30 years.

Guaranteed Universal Life Insurance: This type of life insurance provides permanent life insurance coverage at a fixed price that is guaranteed never to change. The coverage does not focus on cash growth but rather providing affordable permanent life insurance coverage.

Need Help with Life Insurance?

If you’re looking for a life insurance policy and you’re interested in the benefits a cash value policy can offer, we’re here to help.

We offer comprehensive life insurance options to best suit your life, whether you want permanent life insurance, you need insurance that won’t require a medical exam, or you’re just trying to figure out the best insurance company for you, we’re here to help you make sense of life insurance.

Because we know that at the end of the day, you want your family to have peace of mind (and you want to have peace of mind while you’re still alive). A cash value life insurance policy provides you the ideal balance of both.

Need a quote? Need to talk to someone about your life insurance needs? We’ve got your back. Click here to get in touch with us today.

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