What Is Cash Value Life Insurance
12 Min Read | Nov 16, 2022
Remember Jack and those magic beans of his? Well, cash value life insurance promises magic beanslike, you know, cashbut it turns out those beans dont grow into much at all. Thats because life insurance companies arent great at investing and should stick to what they do best: replacing your income when you die.
So, what is cash value life insurance? And whats the cash value of a life insurance policy? Most importantly, is it worth the effort? Well help you cut through the confusion and find the answers youre looking for.
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1. Policy loans from life insurance policies generally are not subject to income tax, provided the contract is not a Modified Endowment Contract , as defined by Section 7702A of the Internal Revenue Code. A policy loan or withdrawal from a life insurance policy that is a MEC is taxable upon receipt to the extent cash value of the contract exceeds premium paid. Distributions from MECs are subject to federal income tax to the extent of the gain in the policy and taxable distributions are subject to a 10% additional tax prior to age 59½, with certain exceptions. Policy loans and withdrawals will reduce cash value and death benefit. Policy loans are subject to interest charges. Consult with and rely on your tax advisor or attorney on your specific situation.
Neither North American Company for Life and Health Insurance® nor its agents give legal or tax advice. Please consult with and rely on a qualified legal or tax advisor before entering into or paying additional premiums with respect to such arrangements.
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Exhibit 78 Whole Life Insurance As A Volatility Buffer
Exhibit 7.8 Whole Life Insurance as a Volatility Buffer
Retirement Researcher
Exhibit 7.9 provides a visual illustration for the median outcome of these strategies by age. Scenario 7 supports the most spending across the age range, but Scenario 6 without the income annuity supports the most legacy across the age range until very late in retirement. Scenario 3 supports the least spending, but it leads to greater legacy than Scenario 7 until about age 85.
Exhibit 7.9 Whole Life Insurance as a Volatility Buffer: Median Spending and Legacy
Exhibit 7.9 Whole Life Insurance as a Volatility Buffer: Median Spending and Legacy
Retirement Researcher
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How Do I Access The Cash In Cash Value Life Insurance
Jack didnt have to wait long for those magic beans to turn into a huge beanstalk. But what is the cash value of a life insurance policyand are you willing to wait 1015 years for some decent cash value? Because thats how long itll take.
Lets say you can wait 1015 years to build up your cash value. How can you take it out? Well, here are your choices, depending on whether youve got whole life or universal/variable life insurance . . .
What Are The Benefits Of Whole Life Insurance And Using It To Supplement Retirement
Whole life insurance is a life insurance policy that also builds up cash value with tax benefits.3 A portion of each premium is set aside and invested in the policy’s cash value, which can be an alternative to saving.
While whole life insurance rates can be quite a bit higher than term life insurance, it offers several unique benefits.
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The Reality Of Universal Life Investment Earnings
When universal life insurance policies were first introduced, the policies were written assuming rates of return from 11% to 15%. Those policies didn’t take into account that as the 20th century ended, interest rates would drop into the single digits, undermining the growth of a policy’s cash value. Policyholders found themselves forced to pay premiums entirely out of pocket. If they couldn’t afford to pay, their policies became worthless. Once that happened, they faced a large tax bill on any sums they’d withdrawn over the yearsundermining a key selling point for these policies.
But what makes universal life so appealing as an alternative to whole life is its flexibility in allowing a policy owner to shift funds between the policy’s insurance and savings components. Some policies also allow you to choose how the funds in the savings component will be allocatedsimilar to how you might choose among different mutual funds for your 401 plan.
Is Cash Value Life Insurance A Good Way To Boost My Retirement Income
This ones easy: No! One of the worst things you can do is buy cash value life insurance with the hopes of it helping you in retirement. The returns will barely keep up with inflation, and youll get hit with tons of fees and commissions.
Youd be much better off buying a term life policy and investing 15% of your household income into good growth stock mutual funds through a Roth IRA and/or 401.
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How Long Does It Take For Whole Life Insurance To Build Cash Value
You should expect at least 10 years to build up enough funds to tap into whole life insurance cash value. Talk to your financial advisor about the expected amount of time for your policy.
Remember that the government taxes those funds. Another option in many cash value policies is that you can take out a loan against your policy. However, youll have to pay interest.
Tapping into cash value is a potential revenue source in retirement. Just weigh the benefits and drawbacks and see if theres another revenue source where you could get funds.
Adding Whole Life Insurance Cash Value As A Volatility Buffer In Retirement
This article is part of a series.
The next potential use for whole life insurance in lifetime financial planning is using the cash value as a volatility buffer asset to help manage the sequence-of-returns risk for investment portfolio distributions. Retirement spending can be sourced to the cash value after a market downturn to avoid selling portfolio assets at a loss. Returns for buffer assets should not be correlated with the financial portfolio, since the purpose of buffer assets is to temporarily support spending when the portfolio is otherwise down. This attempts to allow for portfolio recovery before distributions from it resume. The cash value of whole life insurance has this characteristic since it is contractually protected from declining in value.
A close-up of a joyful senior couple crouching and petting a dog.
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I assume that the whole life policy uses nondirect recognition, which means that there is no adjustment to the growth for the cash value that has been used as collateral for loans. This is a conservative assumption, as policies with direct recognition would support a higher growth rate on the cash value for the loan amount, since the 5% loan rate I assume is larger than the 3% interest rate earned by assets in the general account. Legacy values at age 100 reflect any remaining investment assets along with the remaining net life insurance death benefit after offsetting cash value surrenders and any loans plus accumulated interest.
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How Cash Value Life Insurance Works
Cash value insurance is permanent life insurance because it provides coverage for the policyholders life. Traditionally, cash value life insurance has higher premiums than term life insurance because of the cash value element. Most cash value life insurance policies require a fixed-level premium payment, of which a portion is allocated to the cost of insurance and the remaining deposited into a cash value account.
The cash value of life insurance earns a modest rate of interest, with taxes deferred on the accumulated earnings. Thus, the cash value of life insurance will increase over time. As the life insurance cash value increases, the insurance companys risk decreases, because the accumulated cash value offsets part of the insurers liability.
Your Beneficiaries Receive A Death Benefit
Cash value life insurance is a permanent life insurance policy, which means it can remain in effect until you die as long as you pay your premiums. If you take loans or withdrawals from the policy, you also have to make sure you maintain a minimal cash value level or your policy could lapse.
If you want to make sure your loved ones get something, a cash value policy is likely the better option than term life insurance.
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You Can Pay Your Life Insurance Premium With The Cash Value
- Whether you have whole life or universal/variable:Some folks use their cash value to pay for the monthly or annual premium itself. Thats if theyve built up a big pile of cash, of course! But this makes no sense, because the whole point of cash value life insurance is to use the cash value to spend on the fun stuffnot to use those savings on the actual life insurance bill. This is not smart financial planning.
Notice how all of these ways of accessing the cash value come with a catch? Youll either slash your death benefit, face a heavy tax, or pay a fee. Getting a hold of the cash value without any consequences to you isnt in the insurance companys interests. Its how they make their money, and yet another reason to stay away from cash value life insurance.
Using Life Insurance To Pay For Retirement
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For many people, life insurance and retirement planning are two separate things. Retirement planning is for you, and life insurance is for your beneficiaries. However, some financial advisors also recommend life insurance as one way to plan for retirement.
Because of the costs involved, this strategy is controversial but there can be upsides, if youre a good fit.
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The Premium Will Always Stay The Same
Unlike term life insurance, which must be renewed after a set amount of time at a higher rate, the monthly premium does not go up once you take out your whole life insurance policy. That’s one reason it can be advantageous to take out a whole life insurance policy when you’re younger and healthier and insurance rates are lower.
Pay More Than Your Required Premium To Fund Your Cash Value
To build up enough cash value to supplement retirement, some policyholders choose to overfund their cash value life insurance policies by paying well over the required premium each month. The extra money they pay goes into the policys cash value and grows tax-deferred. But this strategy only works if you dont need to make withdrawals before age 59½: An overfunded cash value policy that exceeds the annual premium limit converts into a modified endowment contract and is subject to additional taxes and penalties for withdrawals.
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Understanding The 2 Types Of Permanent Life
Life insurance is either term or permanent, with term expiring after a certain period and permanent running for the policyholder’s lifespan. Permanent, as mentioned, comes as either whole life or universal.
Whole life insurance offers a consistent premium and a guaranteed cash value accumulation. In return, the premiums are likely to be much higher than they are for term insurance, But the payout is assured. The only risks: that you end up paying more in fees than your return is worth or that the company goes bankrupt.
Universal life offers more flexibility in premium costs, death benefits, and savings because the policies allow policyholders to take advantage of a strong stock market. Universal life policies were very popular as a retirement income vehicle when they were first introduced in the 1980s and 1990s. But a long decline in interest rates pushed monthly insurance premiums much higher, greatly devaluing the cash value of the universal policies bought during that time.
Which Type Of Life Insurance Policy Generates Immediate Cash Value All Things You Need To Know
Whole life insurance and universal life insurance policies are the two types of life insurance that generate immediate cash value. Universal life insurance policies have higher cash values than whole life insurance policies, but both can provide a way for policyholders to access cash in times of need.
Permanent life insurance policies, such as whole life or universal life, have an investment component that generates cash value. This means that you can borrow against the policy or even cash it in for its surrender value.
Term life insurance policies do not have an investment component and therefore do not generate cash value.
If youre looking for a life insurance policy that will generate immediate cash value, a permanent life insurance policy is the way to go.
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See How We’re Different
Many people do not view life insurance as an essential part of a retirement income plan. Life insurance is typically seen as a way to protect families from the early loss of a breadwinner during the working years. However, financial advisors recommend life insurance as it has the potential to be so much more if properly utilized in a comprehensive retirement income plan.
To understand how this work, lets have a look four different types of life insurance plans Unit Linked Insurance Plan , Whole Life Plan, Endowment Plan, and Retirement Plan.
What Is Life Insurance Cash Value
Most life insurance policies have a cash value component. This cash value is the policyholders savings account within the life insurance policy. The money in the cash value account grows tax-deferred, which means that the policyholder does not have to pay taxes on any of the earnings within the account until they are withdrawn.
The cash value can be used for various purposes, such as supplementing retirement income, paying off debt, or covering unexpected expenses.
Two main cash-value life insurance types are whole life and universal life.
Whole life policies have a guaranteed death benefit and cash value growth, while universal life policies offer more flexibility in both the death benefit and the cash value growth.
Withdrawals from the cash value account will reduce the death benefit and may also result in surrender charges, so it is essential to consult a financial advisor before taking any money out of the account. However, the cash value can provide policyholders with valuable peace of mind knowing they can access funds in an emergency.
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Components Of A Cash Value Life Insurance Policy
Cash value life insurance is only available in a permanent life insurance policy. Permanent life insurance policies offer two components:
- Death Benefit:Face Value is the amount paid to beneficiaries when the insured person passes away. This is the life insurance payout.
- Cash Value: an additional feature that might make your policy more valuable because you may be able to access the money while youre still alive.
Which Type Of Life Insurance Policy Generates Immediate Cash Value
Whole life insurance is the type of life insurance that generates immediate cash value. Universal life, indexed universal life, and variable universal life insurance policies generate cash value, but whole life insurance generally has the most flexible options and features for cash value accumulation. From a policy standpoint, whole life insurance is the simplest form of permanent life insurance. Whole life insurance has level premiums and guaranteed death benefits as long as the policy remains in force.
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Whats The Difference Between Permanent And Term Life Insurance
Term life insurance provides a death benefit, which is generally paid to the beneficiary free of federal income tax. The insurance pays the policys death benefit if the insured person dies while the policy is in force. The policyholder keeps the policy active by paying the premium in full each year.
Permanent insurance, on the other hand, is intended to last a persons lifetime. The premium is generally higher than term life insurance because it not only funds the tax-free death benefit, but a cash value account. In addition to the death benefit, the policys cash value grows over time and can be used for a number of purposes, including low-interest loans, while the policyholder is alive. Policyholders can use the cash value account to create an income stream for supplemental retirement income as well, though that may affect the death benefit.
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