What is Cash Value Life Insurance?

Cash value life insurance is more expensive than normal life insurance plans in terms of the premium amount. However, they provide a cash component of savings to the policyholder, who doesn’t have to lose his life. The policyholder can utilize the entire cash component while alive at the maturity period’s end. Further, the maturity amount one may utilize as loans or a source of cash.

They are also called permanent life insurance because they cover the entire life of the policyholder, and they also demand a level of a fixed pattern of payment of premium. Therefore, only a small portion is consumed as the insurance cost. The remaining amount is implemented as a cash component by depositing it in a cash value generation account.

Types of Cash Value Life Insurance

There are typically three types of cash value life insurance.

#1 – Whole Life

It provides coverage for the entire life. It is referred to as a straight life. The premium here depends on age and remains constant even if we grow old. The best time to avail of this is entering at a young age. The cash value grows depending on the rate of interest the company decides. They are available on a premium paying basis for a short time, as well as 15 years, and can extend to 65 years. When going for a short time, the premium rate goes very high.

#2 – Universal Life

This type multiples itself on the deferred taxDeferred TaxDeferred Tax is the effect that occurs in a firm as a result of timing differences between the date when taxes are actually paid to tax authorities by the company and the date when such tax is accrued. Simply put, it is the difference in taxes that arises when taxes due in one of the accounting period are either not paid or overpaid.read more methodology and is also known as an adjustable flexible premium policy. The rate of returnRate Of ReturnRate of Return (ROR) refers to the expected return on investment (gain or loss) & it is expressed as a percentage. You can calculate this by, ROR = {(Current Investment Value – Original Investment Value)/Original Investment Value} * 100read more is less but guaranteed. The insurance company will only invest a small part of the earned premium. The cash value increases if the company earns a good profit with the invested amount. In addition, they offer a no-lapse guarantee, which means the longer we pay the premium, the longer the policy stays in force.

#3 – Variable Life

There is a variation between what we get as a death benefit and what we get as a cash component. It acts as a mutual fundMutual FundA mutual fund is a professionally managed investment product in which a pool of money from a group of investors is invested across assets such as equities, bonds, etcread more where the insurance company will park the premium into several avenues like stocks, bonds, etc. Thus, the company issues the policyholder with a prospectus stating where all the money is invested.

The policyholder has the option to choose different accounts to park the premium. The risk associated here is majorly the investment riskInvestment RiskInvestment risk is the probability or uncertainty of losses rather than expected profit from investment due to a fall in the fair price of securities such as bonds, stocks, real estate. In addition, each type of investment is prone to some degree of investment or default risk.read more. The cash and death benefits here change as the value of the money changes in the different accounts parked by the company.

#4 – Universal Indexed Life

It is the same as universal life: the cash value investment is made towards indexed fundsIndexed FundsIndex Funds are passive funds that pool investments into selected securities.read more or indices like Moody or S&P 500. Thus the value generated is based on the change of indices, which affects the cash value.

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How Does it Work?

  • Cash value life insurance can be more treated as an investment account alongside a life insurance policy. A major chunk of the premium we pay is utilized in an investment account, and the money here multiplies in the form of interest over some time.Generally, every policy has a maturity date, but we can withdraw the sum generated at any point by paying a minor form of penalty as fees. Also, we can utilize the cash generated as collateral for loans or payment of other premiums. Partial withdrawal is also a policy for this type of insurance policy.The premium we pay here goes towards three components, which are as follows: a) The cost of the insurance, which is the amount which the company has to provide a death benefit. b) Fees required by the company to provide the coverage and c) Cash value, an investment account associated with the life insurance policy.

Example

A cash value insurance policy offers two benefits: death benefit and cash value. For example, suppose a person has bought a $50,000 policy, paying a premium of $1,000 yearly. If he dies, his beneficiary instantly gets $50,000 on his death. But suppose he is alive and, after 30 years, wants to utilize the cash component generated from the policy, which is like $10,000. He is free to take the money and use it as a source of cash for his personal needs or even take a loan against it.

Advantages

  • The policy remains in force as long as the premium is paid, and the policyholder receives the death benefit when they die.The premium is constant irrespective of the policyholder’s age, which means the age when you take this policy is when the premium amount is decided.The cash value is generated from certain parts of the premium paid and can act as an asset.Certain companies even pay a dividend on cash value insurance policies.The policyholder also receives tax benefitsReceives Tax BenefitsTax benefits refer to the credit that a business receives on its tax liability for complying with a norm proposed by the government. The advantage is either credited back to the company after paying its regular taxation amount or deducted when paying the tax liability in the first place.read more because the policy grows on a deferred tax system.The policy is quite flexible, where the policyholder can surrender the policy generally after 2-3 years or go for partial withdrawal.We can take a loan against the amount generated or use it for paying other premiums.

Disadvantages

  • The policy takes a long time to build the cash value, and suppose we surrender the policy within the first 10 years; there is hardly any cash return that one can expect.This type of policy is quite costly compared to term life insurance, which comes to around 6-10 times more than the death benefit we would have gotten under term life insurance.Cash value and death benefit are treated differently, meaning when we die, we only get the death benefit, not the cash value generated. The cash value can only be enjoyed when we are alive.Cash value insurance policies provide very low-interest rates on the sum generated. Thus, this cannot be treated as an investment policy because other policies will generate more returns.

Cash Value Life Insurance vs Term Life Insurance

  • The biggest differences between the two are death benefit features and pricing. Term life insurance offers almost 4-6 times more death benefit coverage at 4-6 times lesser cost than cash value life insurance.Cash value insurance, though, has certain investment benefit features added on it, which misses in term life. Still, the return rate is pretty low, whereas if the money was invested in other avenues like mutual funds could easily fetch a 15% return.Term life if you die outside the policy coverage period, the beneficiary receives nothing, and also renewing term life at old age is very costly. Also, sometimes the company doesn’t allow it, whereas cash value once entered is applicable lifelong provided the premiums are paid.

Conclusion

It depends on the policyholder’s choice of which one they prefer to go for, whether it is a cash value or term insurance. However, looking at the advantages and disadvantages, we can clearly state that cash value insurance, though comparatively more expensive than term life, can be a sigh of relief for the policyholder when he is alive and in terms of the need for money. Still, on a death benefit ground, it is a loss because the policyholder is paying more for almost 3-4 times lesser coverage in terms of term life insurance.

This article is a guide to what is cash value life insurance and its definition. Here, we discuss the type, working, and example of cash value life insurance. You can learn more about finance from the following articles: –

  • Calculate Cash Surrender ValueTypes of Risk InsuranceReinsuranceCompare – Term vs Whole Life Insurance