Overview
Cash value life insurance is a type of permanent life insurance policy that not only provides lifelong coverage but also includes a savings element known as the “cash value.” This feature allows the policyholder to use the policy as a financial tool during their lifetime, tapping into the policy’s accumulated cash for loans, premium payments, or direct withdrawals.
How Cash Value Accrues
Each premium paid towards a cash value life insurance policy is split into two paths: one portion covers the insurance cost, and the other goes into building the cash value. This cash value earns interest over time and benefits from deferred taxes, making it a growing, tax-advantaged component of the policy. As the cash value increases, the risk to the insurer decreases, as this accumulated cash can be used towards the death benefit payout.
Utilization of Cash Value
Borrowing Against the Policy
One of the hallmark features of cash value life insurance is the ability to borrow against the accumulated cash value. These loans are tax-free and have flexible repayment terms, although interest will accrue on the loaned amount.
Withdrawals
Withdrawals from the cash value are possible, but they can reduce the death benefit intended for beneficiaries. It’s important to manage withdrawals carefully to avoid diminishing the policy’s primary purpose of providing financial security upon the policyholder’s passing.
Premium Financing
Another benefit of adequately built cash value is using it to cover premium payments, potentially allowing the policyholder to maintain coverage without out-of-pocket expenses when financially necessary.
Benefits of Cash Value Life Insurance
Long-term Financial Planning
Cash value life insurance can serve various long-term financial needs, from contributing to retirement funding to providing a tax-advantaged asset base. The policy’s flexibility in accessing funds adds a layer of financial security for policyholders.
Permanent Coverage
Unlike term life insurance, which only lasts for a designated period, cash value life insurance provides coverage for the policyholder’s entire life as long as premiums are paid, ensuring that beneficiaries are protected.
Investment Component
The cash value can be seen as an investment-like component within the insurance policy, gradually growing and providing potential financial utility for the policyholder.
Considerations
While cash value life insurance offers many advantages, it also comes with higher premium costs compared to term life insurance. Potential policy buyers should consider whether the benefits of building and using the cash value align with their personal financial strategies and goals.
Related Terms
- Term Life Insurance: Insurance that provides coverage at a fixed payment rate for a limited period.
- Universal Life Insurance: A type of flexible permanent life insurance offering both term and investment benefits.
- Whole Life Insurance: Permanent life insurance with a fixed premium and death benefit, while also accumulating cash value.
Suggested Reading
- “The Total Money Makeover” by Dave Ramsey
- “Life Insurance 101” by Michele Cagan
- “Investing For Dummies” by Eric Tyson
Understanding cash value life insurance can seem daunting, but viewing it as both a protective and proactive component of one’s financial strategy can illuminate its value in a well-rounded financial plan.
