Whole Life Insurance Cash Values: Are They Flexible?

Whole life insurance is a type of permanent life insurance that provides coverage for the entire life of the insured person, rather than for a specific number of years. One of the key features of whole life insurance is its cash value component, which allows the policy to function as a savings account, with the potential for tax benefits. The cash value of a whole life insurance policy can be accessed in several ways, such as through withdrawals, loans, or by surrendering the policy. However, it's important to note that accessing the cash value may have implications for the death benefit and could result in tax consequences. Understanding the specifics of whole life insurance and its cash value component is crucial for making informed decisions about financial planning and insurance coverage.

How does cash value accumulate in whole life insurance?

Cash value is a component of some types of life insurance, typically offered within permanent life insurance policies such as whole life and universal life insurance. Whole life insurance is permanent life insurance that pays a benefit upon the death of the insured and is characterised by level premiums and a savings component.

When you make a premium payment for cash value life insurance, it is divided into three parts:

• The policy's cash value
• The insurer's cost of providing the death benefit
• Life insurance company fees and charges

The cash value of a whole life policy typically earns a fixed rate of interest. Withdrawals and outstanding loan balances reduce death benefits.

Whole life insurance policies are further distinguished as participating and non-participating plans. With a non-participating policy, any excess of premiums over payouts becomes profit for the insurer. However, the insurer also assumes the risk of losing money. With a participating policy, any excess of premiums is redistributed to the insured as a dividend. This dividend can then be used to make payments or increase one's policy coverage limits.

The cash value of life insurance earns interest, and taxes are deferred on the accumulated earnings. While premiums are paid and interest accrues, the cash value builds over time. As the life insurance cash value increases, the insurance company's risk decreases, because the accumulated cash value offsets part of the insurer's liability.

Whole life insurance is different from term life insurance, which only provides coverage for a certain number of years, rather than a lifetime. Term life does not have a cash savings component and only pays out a death benefit.

What are the pros and cons of cash value life insurance?

Cash value life insurance is a permanent life insurance policy that lasts for the lifetime of the holder and features a cash value savings component. It is more expensive than term life insurance, but it also has some benefits that term life insurance does not offer. Here are some pros and cons of cash value life insurance to help you decide if it is the right choice for you.

Pros of Cash Value Life Insurance:

• Lifetime coverage: Cash value life insurance provides coverage for the entire life of the insured person, unlike term life insurance, which is only for a specific number of years.
• Cash value accumulation: The policy has a savings component, allowing the policyholder to accumulate cash value over time. This cash value can be accessed during the lifetime of the insured through withdrawals or loans.
• Tax advantages: The cash value component of the policy grows tax-deferred, and any loans or withdrawals up to the total amount of premiums paid are typically tax-free.
• Flexible usage: The cash value can be used for various purposes, such as borrowing against it, withdrawing cash, or using it to pay policy premiums.
• Guaranteed death benefit: The death benefit amount is guaranteed and will not decrease over time, providing financial security for beneficiaries.

Cons of Cash Value Life Insurance:

• Higher cost: Cash value life insurance policies have significantly higher premiums than term life insurance policies due to the permanent coverage and cash value component.
• Slow cash value growth: It can take many years for the cash value to build up to a substantial amount, and the growth rate may be slower compared to other investment options.
• Limited flexibility: Whole life insurance policies have limited flexibility in adjusting the premium or death benefit, unlike universal life policies.
• Policy lapse: Withdrawing too much cash or taking out large loans can cause the policy to lapse, resulting in a loss of coverage.
• Tax implications: Withdrawing more than the total amount of premiums paid may result in tax implications, and unpaid loans can reduce the death benefit for beneficiaries.

How is whole life insurance different from term life insurance?

Whole life insurance and term life insurance are two of the most common types of life insurance available. While both types of policies offer a payout upon the death of the insured, there are some key differences between the two.

How Whole Life Insurance Is Different From Term Life Insurance

Whole life insurance is a form of permanent life insurance that lasts as long as the insured person lives, assuming they pay the policy's premiums. Term life insurance, on the other hand, only covers the insured for a specific number of years, such as 10, 15, or 20 years. Whole life insurance typically has higher premiums than term life insurance due to its lifelong coverage and additional features.

One of the main differences between whole life and term life insurance is the presence of a cash value component in whole life policies. This savings component grows tax-free over time and allows the policyholder to withdraw or borrow against it while they are alive. In contrast, term life insurance does not accrue any cash value, making it purely insurance without a savings or investment component.

Whole life insurance policies usually have level premiums, meaning the amount paid every month remains unchanged. Term life insurance premiums may change over time, with some policies having fixed rates and others increasing at each renewal as the insured grows older.

Another difference lies in the complexity of the policies. Term life insurance is generally easier to understand, as it only provides basic coverage for a finite duration. Whole life insurance, on the other hand, can be more complex due to its additional features and flexibility.

When to Choose Whole Life Insurance

Whole life insurance is a good choice if you want permanent coverage that lasts your entire life. It is also suitable if you want a policy that builds cash value over time, which can be used as a savings vehicle for retirement or other financial needs. Whole life insurance may also be preferred if you have lifelong dependents, such as children with special needs, as it ensures they will receive the death benefit even when they become adults.

When to Choose Term Life Insurance

Term life insurance is often sufficient for most families, especially those with young children and a mortgage. It is a good choice if you only need coverage for a specific period, such as the length of your mortgage. Term life insurance is also much more affordable than whole life insurance, making it a better option if you want lower premium payments. Additionally, term life policies are usually easier to understand, apply for, and get approved.

What are the different types of whole life insurance?

There are several types of whole life insurance policies, which differ based on how premiums are paid. Here is a list of the different types:

• Level Payment: This is the most common type of whole life insurance policy, where premiums remain unchanged throughout the duration of the policy.
• Single Premium: The insured pays a one-time large premium, which funds the policy for life. However, this type of policy usually has tax consequences and is known as a modified endowment contract.
• Limited Payment: With this type of policy, you pay a limited number of premiums, which are higher than those in a level-payment policy but are only paid for a certain number of years.
• Modified Whole Life Insurance: This type of policy offers lower premiums than a standard policy in the first two to three years, and higher-than-standard premiums in the later years, making it more expensive in the long run.

Whole life insurance policies can also be categorised as either participating or non-participating plans. With a non-participating policy, any excess of premiums over payouts becomes profit for the insurer, and they assume the risk of losing money. On the other hand, a participating policy redistributes any excess of premiums to the insured as a dividend, which can be used to make payments or increase policy coverage limits. However, dividends are not guaranteed and can vary based on the company's financial performance.

How can I access the cash value of my life insurance policy?

There are several ways to access the cash value of your life insurance policy. It's important to note that the options available to you will depend on the type of policy you have, so be sure to check with your insurer. Here are some common methods:

Borrowing

You can borrow against the cash value of a permanent life insurance policy. The loan amount will accrue interest until it's paid back in full, and the interest rates are generally lower than those for personal loans or home equity loans. However, an outstanding loan could reduce your cash value growth, and if you die before paying off the loan, the outstanding balance will be deducted from the death benefit your beneficiary receives.

Withdrawing

You can withdraw cash from the policy, but this will reduce the death benefit. Withdrawals up to the amount you've paid in premiums are generally tax-free, but withdrawals above this amount may be taxed as ordinary income.

Surrendering the Policy

If you're willing to end your policy, you can cancel it and receive a surrender cash value payment. This will be the cash value minus any surrender charges, unpaid premiums, or outstanding loan balances. Surrender fees and taxes may apply, and your beneficiary will no longer receive a death benefit.

Using Cash Value to Pay Premiums

If you've built up enough cash value, you may be able to use it to cover your premium payments. This can be helpful if you're looking to reduce expenses but want to keep your policy in place.

Selling the Policy

In some cases, you may be able to sell your policy through a life settlement or viatical settlement. This involves selling your policy to a third party for more than the cash surrender value but less than the death benefit. Once the sale is complete, the buyer becomes responsible for paying your insurance premiums and maintenance fees for the rest of your life, and they will receive the policy's death benefit when you pass away.

Riders

You can add riders to your policy for extra coverage. One common example is an accelerated death benefit rider, which lets you access a portion of the death benefit if you develop certain medical conditions.

Frequently asked questions