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Cash Value Life Insurance


April 29, 2020

What is cash value life insurance? Should I get a term or whole life policy? How much does life insurance cost? If you’re new to life insurance understanding the different types and their features and benefits can be overwhelming. But life insurance is important for everyone, and it’s easier to understand than you might think.

There really are two types of life insurances, and each one has multiple variations. The two principal types of life insurance are term life insurance and whole life or permanent life insurance.

Term life insurance is the simplest form of life insurance. It pays only if death occurs during the term of the policy. These policies can be anywhere from one to 30 years. Most term policies include Conversion options to permanent plans and accelerated benefits for terminal illness at no additional cost.

Permanent Life Insurance pays a death benefit when the insured dies, but there are many variations and benefits provisions depending on the policy you choose. The three main types of permanent life insurance include traditional whole life, universal life, and variable universal life. Each of these has multiple variations.

In this article, we are going to focus on all things life insurance-related. You will learn about the term life insurance and three main types of permanent life insurance and variations within each one. I will walk you through a framework that will help you better understand how to review your policy to see if it still meets your unique needs. We’ll even examine a specific hybrid policy so you can better understand how flexible and unique some life insurance products can be.

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What is Term Life Insurance?

As I already mentioned in the intro, term life insurance is the simplest form of life insurance. It pays only if death occurs during the term of the policy. The primary benefit is a possibly large death benefit. For example, some companies are offering significant amounts of life insurance, and some up to $10 million even without a medical exam!

Typically term life insurance is best for young families to cover an early death. It provides a layer of protection for children, mortgages, educational expenses, debts, and provides an income replacement. The cost is generally low, and based on age, sex, and health.

Term life insurance policies typically come in 10, 20, or even 30-year policies with guaranteed premiums for the entire term period. The policies can be converted to permanent insurance during the term period in some cases. It can also be used in conjunction with permanent cash value insurance as a combo of long-term and short-term protection for families or businesses. We’ll get into how those work later in this article.

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What is Permanent Life Insurance?

As mentioned in the opening, whole life, universal life, and variable life insurance are types of permanent life insurance. Each type has advantages and disadvantages. You’ll need to properly evaluate your family or business needs to know which type best suits you. Now we’ll explore the different types of permanent life insurance and their features and benefits.

Whole Life Insurance

Basic whole life insurance is historically the most common type of permanent life insurance. It provides death benefit,coverage for the life of the insured, and contains a cash value component. From 1940 to 1970 whole life insurance was the most popular insurance product. It was viewed as a way to protect loved ones, while at the same time help subsidize retirement planning. A traditional whole life insurance policy gives you a guaranteed premium and minimum rate of return on your cash value portion. Most pay dividends that increase the cash value and death benefits over time.

Whole Life Insurance Benefits

  • Part of your premium goes towards your cash value.
  • You may be able to eventually use your cash value to pay your premium if you start early.
  • Your premium remains constant during the time you are covered unless you modify the policy.
  • Whole life provides tax-saving opportunities while you are alive and tax free to your estate at death

Is Whole Life Insurance a Good Investment?

At one time it was considered a good investment. Today, however, it’s not necessarily considered a great investment, even though it has an investment like component to it. Depending on market performance and your personal situation, you might consider purchasing a longer span term life insurance with a fixed annual rate, while working with our investment advisors to figure out the best strategy to grow your money.

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Universal Life Insurance

Universal life insurance is another type of permanent life insurance. It has a cash savings component with low premiums that are comparable to term life insurance. Most universal life insurance policies contain a flexible premium option.

How Universal Life Insurance Works

Universal life insurance provides more flexibility than whole life insurance. You have the flexibility to adjust your premiums and death benefits. Unlike a whole life policy that earns cash value through a predetermined rate, the cash value in your universal policy accumulates based on the current market or a minimum interest rate - whichever is greater. As cash accumulates you may access the cash which could affect the death benefits.

You will, however, may need to pay taxes on any withdrawals you make from the excess cash value of your universal life insurance plan if not done correctly or if the policy is terminated. Upon the death of the insured, the insurance company will pay the death benefit minus the loans or withdrawals which you already have received from the cash value.

What about the Universal Life Flexible Premiums?

Unlike whole life insurance policies, a universal life insurance policy does have flexible premiums as mentioned. You’ll have the flexibility of skipping premiums, raising or lowering premiums, making withdrawals and borrowing from the policy as your situation changes over time. Adding to the cash value early provides additional valuable options later on.

Variable Life Insurance

Variable life insurance, another type of permanent life insurance, also comes with a tax favorable cash value component. The cash value component is invested in a number of sub-accounts. A sub-account acts similar to a mutual fund. Typical variable life policies will have several sub-accounts to choose from, with some offering over 50 different options.

People who like variable life insurance accounts are attracted to the investment options and favorable tax treatment for the cash value growth. Annual growth of the cash value account is not taxable as ordinary income. Additionally, the cash can be accessed in later years, and if done properly through loans using the account as collateral, they can be received free of any income taxation.

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Cash Value Life Insurance

The phrase “cash value” is in reference to the savings component of permanent life insurance as mentioned above. When you choose your insurance policy the life insurance part covers your family if you die, and the cash value part acts as a tax-favored savings account that grows your money over time. How much it grows will depend on the type of cash value policy you buy, and what the returns are.

How Does Cash Value Life Insurance Work?

When you make your premium payment on a cash value life insurance policy, one portion of the payment goes to the policy’s death benefit, another portion goes to the insurance company, and the rest goes toward your policy’s cash value. This cash value will grow over the years as you make your premium payments. There is a guaranteed cash value component and a varying cash value component.

How do Policies Accumulate Tax-Favored Cash?

Whole life policies provide a guaranteed cash value account that grows according to a formula the insurance company determines. In addition, dividends can greatly enhance the policy’s cash value. Universal life policies accumulate cash value based on guaranteed minimum and current interest rates. Variable life policies invest funds in subaccounts that operate like mutual funds. The cash value in a variable life policy will grow or decrease based on how well the subaccounts perform. These sub-accounts can be easily re-allocated over time without being taxed and adjusted according to one’s risk tolerance.

Cash Accumulation Value Vs. Cash Surrender Value

The cash value in your permanent insurance policy is equal to the sum of money of the guaranteed cash that builds inside of your policy and any accumulated dividends, interest and account performance. The surrender value is the actual sum of money you will receive when you cancel or surrender your policy.

In most cases, the difference is the charges associated with early termination. Surrender fees will reduce your surrender value. Surrender charges vary by plans and usually decrease during the first 10 to 20 years. Premiums are calculated based on the assumption that you will keep the policy well after the surrender charges are gone.

Cash Value vs. Surrender Value Example

Suppose you purchase a permanent life insurance policy with a death benefit of $200,000. After ten years you’ll have earned $10,000 of cash value in the policy. Imagine your insurance contract states that your surrender charge after 10 years is equal to 35%. In this scenario, if you cancel your policy in 10 years, the insurance company will keep $3,500 and leave you with a surrender value of $6,500.

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What Happens to the Cash Value of Life Insurance at Death?

At death, the death benefits are paid to the beneficiaries. In some cases the death benefits may have been increased by the cash value or been reduced by any cash previously withdrawn. As mentioned above, premiums are calculated based on the assumption that you will keep the policy well after the surrender charges are gone.

How to Get the Most Out of Your Policy's Cash Value

  1. Boost the Death Benefit
    If you’ve accumulated a large cash value in your permanent life insurance policy you may choose to leave a larger death benefit to your beneficiaries.
  2. Pay Your Premiums
    Another option is to pay your premiums with the excess cash or dividends. This could save you thousands in premiums each year. Again, all you need to do is make the request. One of our experienced life insurance advisors should review the pros and cons prior to making these decisions.
  3. Take out a Loan
    You can take out a loan against your policy. Some loans actually continue to earn interest and the difference between what interest you pay and what the policy credits can be as little as zero.
  4. Make a Withdrawal
    If you’re low on funds or need to make a big purchase, you have the option to withdraw some or all of your cash value. This could chip into your death benefit however, depending on your policy and the size of your cash value.
  5. Grow Your Retirement Fund
    You can use these funds as an asset in your retirement portfolio.
  6. Transfer to a new policy via 1035 Tax Free Exchange
    One strategy is to use the cash value in your current policy to fund a new policy with better benefits and premiums. A section 1035 Exchange is an income tax free transfer of the cash value into a new similar policy. In some cases we can eliminate future premiums all together.

We always recommend meeting with our insurance professionals before making these types of changes that can severely affect the policy performance.

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Permanent Life Insurance and Taxes

One of the biggest draws to permanent life insurance is the tax advantages that are not available with any other financial, investment, or cash accumulation product.

Tax-deferred Cash Values

Cash value life insurance is an asset. With business life insurance, policy cash values can be listed as assets on the company balance sheet and used by the company at any time. The tax deferral of cash growth makes life insurance ideal for funding executive compensation plans, creating supplemental retirement income for business owners, and funding a corporate stock redemption plan.

Tax-free Income Via Withdrawals and Loans

Cash value is another tax advantage in both whole life and universal life insurance policies. It provides tax-free access. Policy withdrawals and loans in a life insurance policy are tax free income, as long as the policy stays in force until the death benefit is paid.

It is Important to Review Your Life Insurance Policy

Is your policy still working for you?

Does Your Life Insurance Still Meet Your Needs?

When you purchased your policy you did so because it met a number of needs that matched your lifestyle. The primary reason you got it was likely to protect your family. If you’re older and have adult children, then this aspect has changed and could warrant a policy change.

Life Insurance Policy Review checklist

  • Has your need for life insurance increase or decreased over time?
  • How are low-interest rates affecting your policy performance? Do you need one that will perform better under the current low-interest-rate trend?
  • Your health may have improved which could qualify you for a better plan and posible lower premiums in the future.
  • Has your family or business situation changed?
  • Did you miss payments on some planned premiums?
  • Do you have a valuable conversion privilege in your policy that can be exercised before it ends?

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Hybrid Life Insurance With Long Term Care Benefits

As mentioned in the introduction to this article, we’re going to examine a hybrid life insurance policy to demonstrate how unique and flexible your life insurance policy options are today.

Buying long-term care insurance is a way to prepare for needing help late in life. You may not be able to take care of yourself after a certain age. A long-term care insurance policy helps cover the costs of care when you have a chronic medical condition, a disability, or a disorder such as Alzheimer’s disease. Most policies will reimburse you for care given in a variety of places including your home, a nursing home, an assisted living facility, or an adult daycare center.

What does Care Cost?

View our what care costs map. Sponsor code: Lincoln

One hybrid life insurance plan gives you a flexible option beginning at age 40. It’s a universal life insurance policy with an optional long-term care benefit that gives you the choice of premium payment options of one to 25 years.

Unlike a traditional long-term care insurance policy, you have a set cost that never increases as long as you pay the premiums and don’t take any loans or withdrawals. You can pay a single premium or spread the premium up to 10 years with no further annual payments.

With a hybrid life insurance policy like this, you get more for your money because your policy provides income tax-free reimbursements for qualified long-term care expenses that are worth more than your premium payments.

If you end up never needing care your policy will provide an income tax-free benefit. Your children, or other loved ones, designated as beneficiaries will receive the benefits.

Hybrid funding solutions may be the best way to protect you and your loved ones from long-term care expenses. Here’s why:

  • If you do need care, you have a tax-efficient, dedicated funding source, designed to meet your needs.1
  • Should you not need care, you’re able to give your family a legacy through a death benefit.2
  • And, if you change your mind, you’re able to get money back.3
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Other Types of Life Insurance

So far we’ve covered the most common types of life insurance and the variations of each. But, there are even more types of life insurance that are more specialized for particular groups and individuals.

Key Person (Key Man) Life Insurance

There’s a great need to protect the key people in your organization or in a company that you may be invested in. It provides income tax-free proceeds to the business to cover losses due to the loss of that key person. It helps maintain continuity of the business and helps replace the key person. Usually, a short term life insurance policy is best for this purpose. It’s transferable to the future key person or canceled if no longer needed.

Business Continuation Life Insurance: Keeping the Family Business in the Family

Business continuation life insurance is critical for small business owners and family businesses to continue operating effectively after the loss of one of the owners.

A partnership or closely held corporation should have a buy and sell agreement in place to avoid lawsuits for death disability retirement or dissolution. This agreement will spell out what happens if one of the owners should die. It is important to be sure that there is sufficient life insurance in place to provide the income tax-free cash to fund the buyout.

Often a cross-purchase agreement requires life insurance policies on each owner for their respective interest in the company.

A simple example is a partnership of two people. Owner A insures Owner B for a proper amount and Owner A is the beneficiary of the policy. When owner B dies, the proceeds are received by Owner A, income tax free and is used to pay Owner B’s family according to the terms of the agreement. Owner B does the same by insuring Owner A.

Either Term insurance or permanent cash value insurance can provide significant benefits to these small business owners. Either Term insurance or permanent cash value insurance can provide significant benefits to these small business owners. These policies are transferable to the insured at retirement.

This strategy is very important for family businesses to be able to keep the family business in the family upon the death of one of the family members.

Life Insurance for Estate Planning

Life insurance is an excellent tool to use in conjunction with other estate planning strategies.

For example in a 40% tax bracket upon death life insurance could be a perfect way to provide a very good rate of return for the beneficiaries and heirs.

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Frequently Asked Questions About Life Insurance

Q. What is the cash value of a life insurance policy?
A. It depends on the type of life insurance policy you have, and what you have accumulated over the years.

Q. Is life insurance with a cash value worth it?
A. It can be depending on your goals and lifestyle.

Q. Can you cash out a life insurance policy?
A. You can cash out the cash value on permanent life insurance policies, but not the beneficiary benefits.

Q. What happens to cash value of life insurance at death?
A. Death benefits get paid at death minus any loans, withdrawals and interest already received from the policy.

Q. How do you find the cash value of a life insurance policy?
A. You should see it in your statements.

Q. How long does it take for whole life insurance to build cash value?
A. Usually very little in the early years unless it is “overfunded”

Q. What age should you get life insurance?
A. The best time is when you’re a young adult before age 35 if you want to take advantage of the best premiums.

Q. Who can cash out a life insurance policy?
A. Only the policyholder can cash out a life insurance policy.

Q. Do I get a refund if I cancel life insurance?
A. There is no refund for term insurance but permanent policies usually have cash value upon surrender.

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You should now have a basic understanding of what life insurance is, what it does, and why it’s important. If you don’t have life insurance, haven’t had a policy review recently, or just want to explore more options we can help. Contact us for a free consultation and make sure you have the right plan that protects your loved ones and gives you the most for your investment.