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If you're the type of person who likes a two-for-one deal, cash value life insurance may be appealing. Cash value life insurance is permanent life insurance that earns value and offers policyholders the ability to take loans against their policy. Some individuals use cash value life insurance as a combined retirement savings vehicle and a life insurance policy all in one.
This particular type of policy usually comes with higher premiums, however, and your beneficiaries may not ultimately get much value out of your years of saving. Read on to learn about what a cash value life insurance policy is and whether it's right for you.
How Cash Value Life Insurance Works
Cash value is offered with whole life and universal life insurance policies, which last for the life of the policyholder (or in some cases until the insured reaches age 99). In addition to providing a death benefit if the policyholder dies while the policy is active, this type of insurance also maintains a cash value balance.
Like most insurance, cash value life insurance charges premiums the policyholder must pay to keep the policy active. Typically, this premium goes toward securing a death benefit—the preset amount paid out to beneficiaries upon death. But with cash value life insurance, part of the premium payment accumulates in a cash value balance like a savings account and earns tax-deferred interest.
For example, if you get a $1 million cash value life insurance policy, you'll be charged monthly premiums. Part of these premiums will begin accruing into a cash value balance, which could eventually grow to a sum equal to the policy's face value. There are some options for how to benefit from this policy:
- Keep paying in so that your family has access to a $1 million payout upon your death (they will not receive any unused cash value, however)
- Build up your cash accumulation so that you can easily loan yourself money as needed in your later years from the cash value balance
- Surrender the policy to reclaim the cash value balance and forfeit the death benefit
- Eventually stop paying premiums and use the cash value balance to maintain the death benefit
While cash value life insurance policies come with some valuable benefits, they also tend to cost more that term life insurance, which provides a death benefit but no cash value. Cash value policy premiums may cost five to 15 times as much as term life premiums.
What Happens to the Accrued Cash Value at Death?
When a policy holder dies, the insurance provider pays out the death benefit to the beneficiaries but keeps the cash value balance; beneficiaries do not have access to the accumulated cash value. Some policy holders may consider taking loans from their cash value as they age so they don't lose out on those accumulated savings. But, any outstanding loans from the cash value balance are deducted from the death benefit.
If you want to avoid giving up the cash saved in the cash value portion of your policy, you can cancel, or surrender, the policy and receive the "cash surrender value." You may receive all or just part of the full cash value, depending on your policy. This may be a good option if you need cash now or no longer need to leave behind a death benefit, perhaps because your beneficiary has passed away or no longer needs the income from the policy payout.
It is also possible that you may accrue more cash value than the face value death benefit of the policy, generally after many years of paying a premium. In this case, you may choose to ask your insurer to increase your death benefit, use your cash value to pay your premiums or withdraw some of the cash value. You could also surrender the policy and withdraw the cash value.
Pros and Cons of Cash Value Life Insurance
There are both pros and cons to taking out a cash value life insurance policy. What kind of policy you choose depends on your unique financial circumstances, your budget for an insurance policy and the amount your beneficiaries would need if you were to pass away.
When shopping for life insurance, consider these pros and cons of cash value life insurance:
- Unlike a term life insurance policy, a cash value life policy guarantees coverage until death (or age 99 depending on the policy)
- Gives you access to accrued cash value and the interest earned on it through loans or surrender
- Cash value balance can be used to make premium payments, allowing you to eventually stop paying monthly premiums but retain your coverage
- Pays a death benefit to beneficiaries
- Cash value reverts to policy issuer when death benefit is paid out
- Higher premiums compared with other life insurance options
- If you surrender your policy to take the cash value, you lose death benefit
- Cost of insurance increases with age and may deplete your cash value accumulation
- It may make more financial sense to buy cheaper term life insurance and invest what you'd save by avoiding higher cash value premiums
Alternative Life Insurance Policies
If cash value life insurance is not for you, other types of life insurance policies may offer another option. These tend to be lower cost and may not apply for as long a period of time.
- Term: Term life insurance is life insurance that you can purchase for a set term, perhaps 20 years. During that time you pay low-cost premiums and your beneficiaries would receive a death benefit were you to pass away while the policy was active. It does not accrue cash value.
- Universal: Universal life insurance is permanent life insurance that uses cash value, but is more flexible than whole life policies. Unlike whole life, it has flexible premiums and death benefit amounts.
- Group: Group life insurance is offered to a group of people, such as the employees at a company. It typically covers them during the term of their employment with a death benefit that amounts to a year or two of their pay. You may be able to purchase additional coverage through your group life carrier.
The Best Life Insurance for You
The best life insurance for you is the one that provides the best coverage for your survivors. The main goal of life insurance is to replace your income in the event of your passing so your survivors have time to financially adjust to your absence.
Cash value accumulation is a perk on top of an adequate death benefit. If it is affordable for you, it can be a good way to make cash readily available while also paying into life insurance. But alternatives such as term life insurance offer reasonable coverage for most people.