Cash value life insurance policies provide lifetime coverage combined with an investment account. A portion of your premiums goes into the investment account, the cash value, and this money grows with interest over time. If you decide to cash in your life insurance early and turn over your coverage to the insurer, you’ll receive the cash value of the policy (less fees). You can also access the cash value as a policy loan, use the cash value to pay premiums, or make a partial withdrawal.
what is cash value life insurance?
Cash value life insurance refers to any life insurance policy that not only has a death benefit, but also accumulates value in a separate account within the policy. Every time you make a premium payment, the money is divided into three different categories:
The cash value of a life insurance policy is separate from the death benefit, so your beneficiaries would not receive the cash value if you died. Any cash value left in your life insurance policy when you die goes to the insurer. The cash value of a life insurance policy is essentially the amount of money you would receive if you decided to assign the policy to the insurer or give up your coverage. The cash value behaves like an investment as it grows tax-deferred with interest, as determined by the type of policy, and can be used as collateral for a loan.
Although cash value growth is tax-deferred, it will take several years of compounding to grow significantly. Plus, during the first few years of coverage, most of your premiums are eaten up in the cost of insurance and fees, so cash value buildup is slow.
That’s why we generally don’t recommend a cash value life insurance policy if you’re fairly advanced in age. The higher it is, the more likely the cost of your premiums will outweigh any eventual benefit you see. If you need a permanent life insurance policy to cover estate taxes or leave an inheritance, guaranteed universal life insurance provides lifetime coverage with little or no cash value component.
types of cash value life insurance policies
Cash value life insurance policies are typically permanent, meaning you are covered for your entire life as long as premiums are paid. Some of the most common types of cash value life insurance policies are:
Term life insurance policies have no cash surrender value. this means that if you decide to transfer your coverage to the insurer, you will not receive anything in return. on the other hand, it is also the reason why term life insurance is several times less expensive than cash value life insurance.
The only reason you would get money from an insurer with a term life insurance policy is if it has a return of premium rider. This clause adds to the cost of her premiums, but guarantees that she will receive some or all of the premiums paid if she lives beyond the term of the policy.
dividend and participating cash value life insurance policies
Mutual insurance companies have no shareholders and are essentially owned by their policyholders. therefore, if the insurer makes more money than is needed to run the business, it pays back some of it to policy owners in the form of dividends. if she has a participating cash value life insurance policy, it means she is eligible to receive a dividend. Dividends are not guaranteed, but have been distributed consistently by most major mutual insurance companies for decades.
Dividends are distributed according to the size of your cash value. For example, if Jane had a $20,000 cash value and John had a $10,000 cash value, Jane would receive twice as much dividend as Jon. you can take dividends as cash, use them to pay premiums, or use them to buy additional coverage.
what is 7702 life insurance?
Cash value life insurance policies are sometimes called 7702 life insurance. This just means they comply with section 7702 of the tax regulation. Life insurance policies have a variety of tax benefits, such as the death benefit paid to beneficiaries that is free of income taxes. Section 7702 was created to limit what could be considered a life insurance policy and make sure other investments didn’t get the same tax benefits.
how to access the cash value of your life insurance policy
Cash value life insurance premiums can be incredibly expensive, so it’s important to understand all the ways you can take money out of your life insurance policy. Whether you want to drop your coverage and collect on your life insurance or simply apply for a loan, there are a variety of ways to take advantage of your policy’s cash value.
Even if you no longer want coverage, make sure you don’t let your policy lapse at any time. when a policy lapses, you lose the death benefit, as well as any cash value you might have received.
pay your premiums with cash value
Universal and variable life insurance policies are often preferred because they allow you to use the cash value of the policy to pay premiums. This strategy will only work for a short period of time if you start when the cash value is too small or interest rates are low. Also, you should carefully monitor the cash value to make sure it doesn’t drop too low, or you may lose your coverage. But if you have a fairly large cash value with consistent returns, you can keep the coverage in force for years at little or no additional cost.
Whole life insurance policies generally do not allow you to pay premiums using the policy’s cash value, except if you switch to a paid-up policy. Not all insurers offer this option, but with a paid-up life insurance policy, the cash value is large enough to stop you from paying out-of-pocket premiums. use the cash value to pay premiums. The downside to paid-for whole life insurance policies is that each premium payment is deducted from the policy’s death benefit. Plus, there’s less cash value available for other purposes, like a policy loan.
offer cash value as collateral to borrow from your insurer
A life insurance policy loan is a loan from the insurer in which the cash value of your policy is used as collateral. It can be used to pay for medical expenses, buy a car, or anything else you might need cash for. since the insurer has the funds to cover the loan:
However, if you die while the loan is outstanding, the value of the loan will be deducted from the death benefit your beneficiaries receive.
Borrowing against the cash value of your policy is simple and usually comes with fairly low annual interest rates. but you must pay interest out of pocket annually or carefully monitor the amount of the loan compared to the cash value of the policy.
If you make no interest payments, the interest amount is added to the outstanding balance of the loan. If the total size of your loan ever exceeds the cash value of your policy, the life insurance policy will lapse, canceling your coverage. Plus, you’ll likely have to pay income taxes on the loan.
sell your policy in exchange for a life insurance settlement
If you want to drop your coverage and cash in on your life insurance policy, you should first try to sell it in a life insurance cash settlement. you may want to do this if your premiums are high and you no longer have dependents, or if everyone is financially secure. In a life insurance cash settlement, a company purchases your life insurance policy for an amount greater than the cash value but less than the death benefit. Some companies even buy cash term life insurance policies, but only if you’re old enough or sick enough that you’re likely to die during the term of the policy.
You will have to pay income and capital gains taxes on the deal. Keep in mind that any broker who helps link you to a settlement company will usually take a cut. but the net effect is that you’ll usually get more money than you would if you canceled your policy.
Once the policy is sold, the life insurance settlement company takes over the premium payments and becomes the beneficiary of the policy. The downside is that you won’t always find a buyer, and the evaluation process by a life insurance settlement company can take several weeks.
turn in your life insurance policy for its net cash value
If you can’t get a settlement and want to collect on your life insurance, you can turn your policy over to the insurer. simply tell your insurer and they will pay you the net cash value of the life insurance policy.
Net Cash Value is the “real” surrender value of the policy. you’ll usually find it listed separately on your life insurance statements. net cash value will generally be lower than your total cash value accumulated during the first few years of coverage as it is reduced by fees and surrender charges. however, if you’ve had your policy in force between 10 and 15 years, the net cash value is likely to be close to or equal to the total accumulated cash value.
make a partial cash value withdrawal
If you don’t want to completely get rid of your life insurance coverage but have fewer financial obligations, you can also withdraw a portion of the cash value. This provides you with cash while reducing the death benefit of the life insurance policy. For example, if your children have done well in their careers, you may be less concerned about passing on an inheritance but still want some coverage for your spouse.
How a partial withdrawal works can vary by life insurance policy:
increase your death benefit with paid additions
If it has considerable cash value but you don’t have a use for it, you may be able to increase the amount of money left to your beneficiaries. This option isn’t always available, so you’ll need to check with your insurer, but it’s an easy way to make sure your family doesn’t lose the cash value you’ve built up over time.
Similarly, if you have a participating whole life insurance policy from a mutual insurer, you can use the dividends you receive to purchase paid-up additions. Buying paid add-ons is similar to buying a small single-premium life insurance policy in that it increases the policy’s cash value and death benefit, but has no ongoing payments.
Finally, there are no medical exams or underwriting requirements involved in purchasing paid add-ons, so you can increase your coverage even if your health has worsened.