More on Life Insurance
More on Life Insurance
Cash value life insurance refers to any type of permanent life insurance that comes with an investment-style savings component, called the cash value.
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Term life insurance, which is affordable and straightforward, is the right choice for most people. A term life policy lasts for a set period, usually between 10 to 30 years, then expires.
Cash value life insurance on the other hand, lasts your entire life and also includes a savings component. The cash value works like an investment or savings account and grows tax-deferred over the life of the policy. Any type of life insurance that offers this feature is considered cash value life insurance.
A policy’s cash value can be withdrawn, used to take out a loan, and, in some cases, used to pay the policy’s premiums. But cash value life insurance also comes with certain risks.
Cash value life insurance, also known as permanent life insurance, doesn’t expire and comes with a tax-deferred savings component
Cash value life insurance policies typically cost 5 to 15 times more than term life insurance for the same death benefit amount
Because cash value life insurance is more expensive and more complicated than term life insurance, it isn’t recommended for most people
Cash value policies usually come with limited investment options and relatively low rates of return
The death benefit of a cash value life insurance policy works the same way as it does with term life insurance: The policyholder pays either a monthly or annual premium to keep the policy active. If the policyholder dies, any beneficiaries receive the death benefit, usually a tax-free lump sum of money.
But with a cash value life insurance policy, when you pay the premium, a certain percentage also goes into a tax-deferred savings component, known as the cash value of the policy. (The exact amount that goes into savings is determined by your individual policy.) The cash value account grows over time.
There are several different types of cash value life insurance, and each accrues cash value differently. Here’s how a few of the most common types of policies work:
Whole life insurance cash value earns interest at a rate set by the life insurance company. Mutual insurance companies also pay dividends.
Universal life insurance cash value earns interest at a variable rate set by the life insurance company.
Variable life insurance cash value is invested in sub-accounts offered by insurers that work much like mutual funds. The performance of the cash value is based on the returns of those sub-accounts. Premiums remain level.
Variable universal life insurance cash value is invested in sub-accounts offered by insurers that work much like mutual funds. The performance of the cash value is based on the returns of those sub-accounts. Premiums can vary and are up to the policyholder.
Indexed universal life insurance cash value is invested in a stock market index (such as the S&P 500) selected by the insurer. Most policies have both an interest rate floor and ceiling, meaning that the cash value growth won’t go below or above a certain range.
Guaranteed universal life insurance has minimal to no cash value accumulation.
Though term life is sufficient for most people, a permanent life insurance policy with cash value may be useful in a few scenarios.
The first consideration should always be whether or not you can afford the policy. Because cash value life insurance policies cost much more than comparable term life insurance, many are dropped prematurely or don’t provide a proper level of coverage.
Cash value life insurance policies can make sense for people with complex financial needs, including:
High-income earners who have already maxed out their other retirement accounts and are seeking an additional vehicle for tax-deferred savings.
People whose children have special needs or who have other lifelong dependents.
High-net-worth individuals who are looking to build a tax-free inheritance for their children or offset the costs of an estate tax on their assets.
Compared to term life insurance, which is typically affordable, cash value life insurance can be expensive. Cash value life insurance policies, like whole life insurance, can be five to 15 times as expensive as a comparable term life insurance policy.
Cash value life insurance costs more than term life for a few reasons:
It lasts longer: cash value life insurance is a type of permanent life insurance, so it does not expire. Term life insurance is cheaper because it only lasts as long as the term length.
It has a cash value component: as we previously mentioned, in addition to life insurance, you also get a cash value component with a cash value life insurance policy. With cash value life insurance, your premium payments are split between these two components, which leads to higher rates.
It has more fees: like any traditional investment account, a cash value component means you have to pay management fees, which are incorporated into your premiums.
The cost of life insurance, including permanent policies with cash-value components, is determined by five factors: policy type, health, age, hobbies, and gender.
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Cash value life insurance, like all life insurance policies, comes with its own set of benefits and drawbacks that are worth considering when you’re purchasing a life insurance policy. Cash value life insurance can open up loan and investment options, but it can also be prohibitively expensive to maintain and there are more lucrative ways to grow your savings.
|PROS OF CASH VALUE LIFE INSURANCE||CONS OF CASH VALUE LIFE INSURANCE|
|Life insurance coverage lasts your entire life.||It takes a long time to build up the cash value. Most of the growth happens when you’ve have the policy for two or three decades, so if you surrender it within the first 10 years, it’s unlikely that your cash value will be greater than the total premiums you have paid.|
|You can take out a policy loan (with lower interest rates than other types of loans) against the cash value.||It's expensive. Cash value life insurance policies typically cost 5-15 times more than term life insurance for the same coverage amount.|
|Use the cash value to pay for your policy's premiums once you've accumulated enough. This can be a great way to avoid a policy surrender due to unpaid premiums, but usually you can only do this after at least one year of owning the policy.||Higher chance of policy surrender. According to one study, about 45% of people who purchase cash value insurance surrender their policies within the first 10 years due to higher premiums.|
|Cash value life insurance can be a useful retirement income supplement to your 401(k) or Roth IRA. It's still vulnerable to market fluctuations, but usually has a guaranteed rate of return. You can access the cash value instead of dipping into your savings or IRA.||Cash value isn't added to your death benefit. Your beneficiaries are guaranteed to receive the death benefit payout when you die, but you can only utilize the cash value component while you are living.|
|If you need the cash or no longer need life insurance, you can surrender the policy and take the cash.||There are better ways to invest. Cash value has limited investment options and relatively low rates of return (only 3% to 4%) compared to dedicated investment options, such as a 401(k) or IRA.|
|Cash value gains are tax-deferred, much like gains from a 401(k). That means withdrawals less than or equal to what you’ve paid into the policy – the cash basis – are not taxable, but withdrawals greater than the cash basis are taxable.||Unpaid policy loans are taxable. Any unpaid loans (from a policy lapse or if you die before your loans are repaid) against your policy's cash value are taxable|
|If you surrender your policy for the cash value, any profit you've made is subject to tax. And if you surrender the policy during the first two to three years, you may not get any of the cash value, or you may be subject to high administrative fees.|
|If you deplete the entirety of the cash value to pay your premiums, your policy will lapse.|
|If you overfund your cash value's annual premium limit (set by the IRS), then your policy may convert to a modified endowment contract (MEC). MECs are subject to additional taxes and penalties for withdrawals.|
Anyone considering surrendering a life insurance policy should talk to a licensed life insurance agent or a financial adviser. They can walk you through the process and let you know about any available alternatives so you don’t make a mistake that costs you your savings and your life insurance.
Determining your life insurance needs is the first step to buying life insurance. Once you’ve decided cash value life insurance is right for you, here are the next steps:
As a general guideline, we recommend that you get about 10-15 times your annual income in life insurance coverage to make sure these costs are covered. But if you have outstanding debts or other expenses, you might need more coverage.
To apply for life insurance, you’ll need:
Proof of identity, citizenship, and age, like a driver’s license, birth certificate, or a valid passport. Noncitizen residents can use their green card (permanent resident card) or an employment authorization card.
Proof of income. You can use pay stubs, a letter of employment, a tax return, or an earnings statement from your bank if your primary income is from interest or rent. If you’re unemployed, an unemployment letter or monthly statements describing your unemployment benefits will work.
Proof of residency. For renters, that could be your signed lease or a rent receipt. For homeowners, your mortgage bill or a property tax statement will suffice. Insurers will also accept a utility bill or a postmarked envelope with your return address on it.
Social Security number. You don’t need your card, but you should know the number because you’ll likely have to provide it for some preliminary background checks.
Each life insurance company treats specific factors differently, so you’ll pay the most affordable premiums by shopping around with multiple insurers as opposed to working with just one. Working with an unbiased, independent broker like Policygenius ensures you find a company that caters to your specific life insurance needs at the most competitive price.
To accurately calculate your premiums and determine your insurability, life insurance companies require you to complete an application and in most cases, a follow-up phone interview. You’ll be asked about your hobbies, lifestyle, finances (including income and net worth), driving record, and about any other life insurance policies you may have.
You’ll also be asked questions about your health, medical history, and prescriptions. Depending on the insurer and type of policy you apply for, you may also be asked to authorize your doctor to write an attending physician statement (APS) that details your health information.
Some life insurance companies offer no medical exam life insurance, but in most cases, after your phone interview, you’ll schedule your medical exam. The life insurance medical exam is free to you and similar to your yearly physical, except that you have the option of the medical examiner coming to your home or office.
The technician or nurse will take basic measurements like your height and weight, blood pressure, and pulse, and you’ll also provide a blood and urine sample. The entire process should take just about 30 minutes.
This part is easy. After your application, interview, and exam are over, you just have to wait for the insurance company to complete underwriting. This can take four to six weeks, but sometimes longer if your application is more complicated.
Once you’re issued a policy offer, if you agree to the terms, you can sign the policy documents and pay your first premium. A policy does not go in force until you actually sign. Depending on your insurance company, you may have to electronically sign or may be required to mail the documents back.
Make sure you keep a signed copy of your policy somewhere safe where your beneficiaries can easily access it.
Because of cash value life insurance policies’ high cost, they’re usually not the best choice when it comes to life insurance. Most people would benefit more from getting a term life insurance policy and then investing the difference in traditional investment options.
A term life policy, which is meant to protect your dependents for the time period when they rely on your income, is sufficient for most people. That’s because as you age, your financial obligations – such as paying off a mortgage or supporting children – usually decrease and you stop needing life insurance coverage.
For some individuals with a unique set of circumstances, cash value could be a good policy option once they have maxed out all other investment vehicles. You should consult with a financial advisor or independent broker like Policygenius to determine the best life insurance option for you.
A tax-deferred savings component. When you pay premiums for a cash value life insurance policy, a certain percentage goes into a cash value account, which can accumulate value over time like an IRA or 401(k) account.
Most permanent life insurance policies have a cash value component, including whole life insurance, universal life insurance, variable life insurance, variable universal life insurance, indexed universal life insurance, and guaranteed universal life insurance.
The cash value of your policy can only be used while you are alive and goes back to the insurance company when you die. However, your beneficiaries still receive the death benefit payout, minus any outstanding loans (if applicable) against your policy’s cash value.
Rebecca Shoenthal is a life insurance editor at Policygenius in New York City, specializing in buying life insurance and the ins and outs of life insurance ownership. She's edited business books by the country’s top academics, politicians, journalists, thought leaders and CEOs, including venture capitalist John Doerr’s Measure What Matters, entrepreneur Scott Belsky's The Messy Middle, NYU Stern professor Scott Galloway's The Four, and technologist John Maeda's How to Speak Machine.
Nupur Gambhir is a life insurance editor at Policygenius in New York City. She has researched and written extensively about life insurance since 2019, with specialties in life insurance companies, policy types, and end-of-life planning. Her writing on insurance and finance has appeared on MSN, The Financial Gym, and end-of-life planning service Cake. Previously, she worked in marketing and business development for travel and tech.
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