Cash Value Life Insurance Explained

February 20, 20236 min read
Cash Value Life Insurance Explained
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Key Takeaways:

  • Cash value life insurance is a type of permanent life insurance that offers a death benefit to surviving family members as well as an investment or savings vehicle.
  • Policyholders can tap into their policy’s cash value by borrowing against it, making withdrawals, or “surrendering” their coverage.
  • If the policyholder accumulates sufficient cash in their account, they might be able to use it to cover premium payments.

Some types of life insurance have a cash value component, meaning one can take money from their policy. In fact, cash value insurance can be used as an investment or interest-earning savings account. But such policies are not for everyone. The following explains cash value life insurance and how it fits in retirement plans.

What is Cash Value Life Insurance?

Cash value life insurance is a type of permanent life insurance that offers a death benefit to surviving family members as well as an investment or savings vehicle.

The cash value component typically grows tax deferred and earns interest or other investment gains. Note, though, that the cash value element makes premiums higher than for term life insurance.

Policyholders can tap into their policy’s cash value by borrowing against it. In that case, the loan amount accrues interest – the amount varies with state law — until it is fully repaid. Policyholders may also make withdrawals. If the amount withdrawn includes investment gains, that portion is taxable. Loans as well as withdrawals will in the future decrease the life insurance payout to beneficiaries.

In addition, the policyholder can “surrender,” or cancel coverage. In so doing, they can get back the cash value less any surrender charge.

How Does Cash Value Life Insurance Work?

In essence, part of the insurance premiums one pays for a permanent life insurance policy goes toward building cash value. The policyholder may access the cash value to use however they wish.

For example, say a cash value life insurance policy has a $25,000 death benefit. With no outstanding loans or cash withdrawals, the policy has an accumulated cash value of $5,000. The policyholder’s death triggers a full death benefit of $25,000. The $5,000 becomes the insurer’s property, making the real liability cost to the life insurance company $20,000.

What Fees are Involved in Cash Value Life Insurance?

Cash value life insurance premium payments go toward the policy’s cash value as well as to the cost of insuring the policyholder. It also goes to policy fees largely related to account administration. There also may be fees related to loans or withdrawals.

What are the Different Types of Cash Value Life Insurance?

The way in which each policy type accrues value varies, although cash is always available through a withdrawal, loan, or surrender. The types of cash value life insurance include:

  • Whole. A type of permanent life insurance policy, whole life insurance offers a fixed monthly premium and guaranteed death benefit. Cash value accumulates at a base guaranteed rate.
  • Universal life. The most common of cash value life insurance policies. Note, though, that not all types of universal life build cash equally, so investors should choose wisely.
  • Variable life. A permanent life insurance policy that has an investment component. Its cash value element is invested in assets such as mutual funds.
  • Variable universal life insurance. A type of permanent policy that invests some or all of the holder’s cash value in subaccounts linked to the stock market.
  • Indexed universal life insurance. This type provides a death benefit combined with a cash value account. The money in the account can earn interest based on a stock market index selected by the policyholder’s insurer.

How to Know Which Type of Cash Value Insurance is for You

Life insurance is not one-size-fits-all. When shopping for a policy, it would be wise to consider the features for each insurance type and decide what would work best, in accordance with personal needs and goals. A financial advisor can provide guidance.

How to Use the Cash Value

In general, people take money from the cash value of their policy when they need tax-free cash. Common uses include to help pay for college, pay down on a home, or to pad an emergency fund.

If the policyholder accumulates sufficient cash in their account, they might be able to use it to cover premium payments.

What are the Advantages and Disadvantages of Cash Value Life Insurance?

There are benefits and drawbacks to most things, including cash value life insurance.

Pros:

  • The policyholder can borrow against the cash value.
  • Life insurance is permanent – it lasts throughout the policyholder’s life.
  • Cash withdrawals are tax advantaged.

Cons:

  • Premiums are relatively more expensive.
  • Withdrawals will lower the death benefit.
  • Unpaid policy loans, plus interest, will be deducted from the death benefit.

What is Term Insurance?

Term insurance, which is not cash value insurance, provides coverage for a certain time period, such as 10, 20, or 30 years. If the policyholder dies during that period, and the policy is in effect, a death benefit will be paid.

How Does Cash Value Life Insurance Differ from Retirement Savings?

While permanent life insurance does come with an investing feature, many financial experts contend it is more cost effective to invest in an individual retirement account and buy a relatively more affordable term life policy.

But again, it all depends on one’s needs and investment time horizons. Those aiming to build a nest egg over some decades might want to use cash value life insurance as a savings option, along with an IRA or 401(k) account.

How to Build a Successful Retirement Portfolio

Successful, thriving retirement portfolios are typically diversified. In other words, their holdings include alternatives to stocks and bonds — assets such as art and real estate that are not directly tied to volatile public markets and which can provide steady secondary income.

One way to diversify using alternatives while saving for retirement is through a private market IRA such as the one offered by the alternative investment platform Yieldstreet. Electronic fund transfers are available from nearly every major IRA and 401(k) provider.

Yieldstreet IRA

Strengthen your future with a private market IRA.

Alternative Investments and Portfolio Diversification

Traditional portfolio asset allocation envisages a 60% public stock and 40% fixed income allocation. However, a more balanced 60/20/20 or 50/30/20 split, incorporating alternative assets, may make a portfolio less sensitive to public market short-term swings.

Real estate, private equity, venture capital, digital assets, precious metals and collectibles are among the asset classes deemed “alternative investments.” Broadly speaking, such investments tend to be less connected to public equity, and thus offer potential for diversification. Of course, like traditional investments, it is important to remember that alternatives also entail a degree of risk.

In some cases, this risk can be greater than that of traditional investments. This is why these asset classes were traditionally accessible only to an exclusive base of wealthy individuals and institutional investors buying in at very high minimums — often between $500,000 and $1 million. These people were considered to be more capable of weathering losses of that magnitude, should the investments underperform. However, that meant the potentially exceptional gains these investments presented were also limited to these groups.

To democratize these opportunities, Yieldstreet has opened a number of carefully curated alternative investment strategies to all investors. While the risk is still there, the company offers help in capitalizing on areas such as real estate, legal finance, art finance and structured notes — as well as a wide range of other unique alternative investments.

Learn more about the ways Yieldstreet can help diversify and grow portfolios.

Summary

A cash value life insurance policy is a comely option for many life insurance buyers. However, investors might want to first consider maximizing other savings options such as IRAs. If the IRA allows diversification through alternatives, that is likely even better.

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