Whole life insurance, a type of permanent life insurance, is one of the most popular types, mainly due to the cash value component that’s included in it. Whereas term life insurance, also known as “pure” life insurance, provides a death benefit to the policyholder’s beneficiaries, whole life insurance does this, plus it allows a cash value to accumulate over the lifetime of the policy. Many whole policies also offer dividends, another way owners can make money through their life insurance policies.
If you’re considering buying a whole life insurance policy but don’t exactly understand the cash value component, read on.
How Does Whole Life Cash Value Work?
The cash value of whole life insurance is an important component of the policy. The way it works is that a portion of the monthly premium you pay goes toward your death benefit and another portion goes toward a cash value account. The funds in that account grow tax-deferred. (And yet another small portion goes to the insurer for operating fees.)
Whole life insurance essentially performs two functions: it acts as a financial safety net for loved ones AND also as a savings vehicle. For this reason, the monthly premiums are much higher than those of term life insurance.
Benefits of Life Insurance with Cash Value
Why would someone choose whole life insurance when there are other savings tools available? The cash value component of whole life insurance offers several benefits. These include:
Investment & tax-deferred growth
With whole life insurance, you don’t need to pay taxes on interest, dividends, or capital gains on the cash value. That’s one reason people choose it as their preferred investment vehicle. Other reasons people choose whole life insurance are that they:
- Are in a high tax bracket
- Have maxed out their retirement plans
- Need it as an estate planning tool
- Don’t like risky investments
- Have a family member with a disability
Bear in mind, while there are advantages of saving with cash value whole life insurance, there are also several disadvantages. If you want to learn more about whether cash value life insurance is a good investment, read our blog post on this topic here.
Borrow against it
You can borrow against the cash value of your whole life insurance policy, usually at a lower rate than other loans. This type of loan is one way parents pay for their children’s college education, but it can really be used for any purpose during your lifetime, including paying for unexpected medical bills, caregiving, etc.
Pay your monthly premiums
Once you’ve accumulated enough cash value, you can ultimately use it to pay your monthly life insurance premiums.
Withdraw cash during your lifetime
Some whole life insurance policies offer accelerated benefits, which allow you to actually use (not just borrow against) a portion of the death benefit during your lifetime. This can be useful if you have emergency situations.
Many whole life insurance policies come with non-guaranteed dividends, in addition to the cash value component. Dividends are an annual payout that the policyholder receives — they come either from excess premium payments and a share in the company’s profits.
Dividends, like the cash value, can be used in many ways, and they are a big benefit of whole life insurance. But beware — some companies offer higher dividends than others, while some don’t offer any and dividends are never guaranteed. To learn more about permanent life insurance dividends, read this comprehensive article.
One way to use dividends that bears noting here is that dividends can get added to the cash value of your policy — and at the same time, they add to the death benefit. This means that you can effectively use dividends to increase your death benefit.
Surrendering Your Policy
The flip side of not needing your cash value during your lifetime is if you need all of it. In some cases, it can happen that you incur unexpected expenses during your lifetime and want to access all of the death benefit. To do this, you must surrender your policy. Bear in mind, for universal life policies the insurer will charge a surrender fee, but only within the first 10 to 15 years of policy ownership.
Whole life insurance with a cash value component has several valuable benefits that you can enjoy during your lifetime, including borrowing against the cash for lower loan rates, withdrawing a portion during times of need, and receiving annual dividends.
However, because the cash value component can get complicated, it’s important to know exactly what you’re getting into and how to maximize it. Speaking with a financial planner and insurance advisor can help you make the best decision.
Still have questions? We have answers! Read on to find out more about the cash value of whole life insurance.
How does a whole life policy build cash value?
The life insurance premiums you pay every month get divided up. A portion goes toward the policy’s death benefit, another portion goes into the cash value account that grows tax-deferred, and yet another smaller, yet significant, portion goes toward paying the insurer’s operating costs and fees. Since this type of life insurance includes so many more components than term life insurance, it can be anywhere between 5 to 15 times more expensive.
The money in your cash value account is usually invested by the insurer into a conservative-yield investment, so that your interest earnings will grow over the years.
How long does it take for whole life insurance to build cash value?
In the first few years of policy ownership, the majority of your premiums go toward the death benefit and insurer fees, so the accumulation of the cash value is low. As you get older, the proportions change and more goes toward the cash value component.
Can I withdraw cash value from life insurance?
Yes, either as a loan or withdrawal or complete surrender.
What can I use the cash value for?
The cash value of your whole life insurance policy can be used for several things during your lifetime, including borrowing against it, withdrawing a portion of it, paying life insurance premiums, and more.
What does surrendering your policy mean?
Surrendering your whole life insurance policy, also known as cashing in or cashing out, means that you cancel your policy. This means that you forfeit the death benefit, no longer pay monthly premiums, and receive the entire accumulated cash value. Your whole life insurance surrender value will be the amount that’s accumulated over the years.
What is the best cash value whole life insurance?
There are several different types of life insurance that come with a cash value. Whole and universal are two of the most popular. With whole life insurance, your monthly premium is fixed and cash value accumulates at a guaranteed rate plus the potential of accumulating dividends. Universal life insurance is more flexible and allows you to adjust the death benefit and premiums.
Guaranteed issue is another type of whole life insurance that builds cash value, but not always (so make sure to check if this is important to you). With guaranteed issue, the main attraction is that there is no medical exam required and acceptance is guaranteed. Coverage is very limited with most companies maxing out between $25,000 and $40,000, which means that the cash value component won’t get very high. This type of life insurance is usually chosen by people who have complicated health issues and can’t get approved for other types of policies. You can learn more about this option in our blog post here.
The question of which cash value policy is best is subjective and must be decided on an individual basis. If you need guidance about which type is best for you, you can contact Sproutt insurance advisors.