Fidelity Life: How the Cash Value of Life Insurance Works
What is cash value?
Cash value is a growth component that is part of a permanent life insurance policy. A portion of each premium paid by the insured goes into the cash surrender value. It then begins to grow tax-deferred at a specific rate, depending on the type of permanent policy.
Once a policyholder has increased their cash value enough, they can take advantage of it in several ways:
- Remove: Policyholders may be able to withdraw some of their cash value with certain types of policies. This may reduce the death benefit and the gains may be subject to tax.
- Borrow from it: With sufficient cash value, policyholders can take out a low-interest, no-credit-check loan. They can redeem it at their leisure, as long as it does not exceed the remaining cash value.
- Pay premiums: Some policies may allow policyholders to cover part or all of their premiums with their cash value.
- Surrender of the policy: Policyholders can get their full cash value less surrender charges if they surrender their policy. Any winnings may be subject to taxes.
Types of Permanent Life Insurance Policies with Cash Value
Several forms of permanent life insurance policies offer a cash value component. But each works slightly differently. Here are some of the most common policies with a cash value:
End-of-stay expense insurance
End-of-life expense insurance is a type of whole life insurance policy that can help cover end-of-life expenses like funeral and burial expenses. It is an affordable life insurance option for seniors who want to ensure their loved ones get the financial protection they need in the event of the policyholder’s death.
The premiums paid by the insured will go towards the death benefit and cash value, which has a fixed interest rate. Once the policyholder has built up sufficient cash value, they may be able to borrow without a credit check at a low interest rate or withdraw from it. If they decide they no longer need the policy, they can surrender it and receive the cash value they have accumulated.
Universal life insurance
Universal life insurance offers a cash value with a fixed rate, but it also has an adjustable death benefit (remember policyholders may have to undergo another medical exam if they want to adjust it) . Also, increasing the death benefit may increase the insured’s premiums.
These policies also come with flexible premiums. When a policyholder has enough cash value, they can use it to cover some or all of their premium payments. That said, if they run out of cash value, they will have to start paying premiums out of pocket again.
Indexed universal life insurance
Indexed universal life policies share some of the same features as universal life policies: adjustable death benefits and the ability to pay premiums with cash value. But with this type of permanent life insurance, the insurer invests the cash value in a fund that tracks a stock market index, such as the S&P 500 or the Nasdaq. As a result, policyholders can potentially earn more growth on their cash value.
In addition, insurers offer minimum interest rate guarantees on indexed universal life insurance cash values. If the market malfunctions, this ensures that the insured still makes money.
Variable life insurance
Variable life insurance policies have adjustable death benefits and the ability to pay premiums with cash value. Like indexed universal life policies, the cash value can be invested. But with this type of life insurance, the policyholder can invest the money in a wide variety of individual investments, such as stocks and bonds, for greater growth potential than any other type of permanent policy.
That said, there is no guaranteed minimum interest rate on variable life insurance policies. This means that policyholders can lose money if their investments lose value.
The bottom line
Cash value life insurance generally costs more in premium than term life insurance and provides coverage for life. So this type of life insurance may be better suited to policyholders who want the peace of mind of guaranteed coverage and need an additional way to build wealth. If a policyholder feels cash value life insurance is right for them, choosing the right type of policy is a matter of risk tolerance.
Policyholders who prefer less risk and less effort could opt for a whole life insurance policy. It has fixed interest, premiums and death benefits. Every other policy expands the options for customizing these features and investing cash value. Ultimately, policyholders should closely compare the features and benefits of each policy type and individual insurers before switching to a permanent life insurance plan.
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Source: Fidelity Life