Life Insurance Cash Value: A Smart Investment Move?

Cash value life insurance is a type of permanent life insurance that features a cash value savings component. This means that, in addition to providing a death benefit, the policy also allows the policyholder to accumulate cash value over time, which can be accessed for various purposes while they are still alive. The cash value typically grows through interest or investment gains and offers tax advantages, such as tax-deferred status on accumulated earnings. While cash value life insurance can be a useful tool for building wealth and accessing funds, it is important to consider the higher premiums, potential risks, and impact on the death benefit when deciding if this type of policy is a suitable investment option.

Cash value life insurance as an investment tool

Cash value life insurance is a type of permanent life insurance that lasts for the lifetime of the holder and features a cash value savings component. This savings component can be used as an investment tool, providing funds that the policyholder can access during their lifetime.

The cash value of a life insurance policy is a portion of the premium payments that are allocated to a separate account, where it accrues tax-deferred interest. This cash value can be used for various purposes, such as borrowing against it, withdrawing cash from it, or using it to pay policy premiums. The cash value typically grows over time, as the interest accrues, and can be a useful source of wealth for the policyholder.

There are several types of life insurance policies that offer a cash value component, including whole life, universal life, and variable life insurance. Each of these policies has different features and levels of risk associated with them. For example, whole life insurance offers a fixed monthly premium and a guaranteed death benefit amount, while variable life insurance allows the policyholder to choose where to invest their cash value, which can lead to higher returns but also carries more risk.

When considering cash value life insurance as an investment tool, it is important to weigh the benefits and drawbacks. On the one hand, it offers lifelong coverage, flexible access to funds, and reasonable premiums. On the other hand, it may take a significant amount of time for the cash value to accumulate, and the death benefit may decrease if the policyholder takes cash value from the policy. Additionally, the cash value may revert to the insurance company upon the policyholder's death, rather than being passed on to beneficiaries.

Overall, cash value life insurance can be a useful investment tool for individuals who want to build wealth over time and have the ability to access their funds while they are still alive. However, it is important to carefully consider the features and risks associated with different types of policies before making a decision.

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. The policyholder can use the cash value for several purposes, including borrowing or withdrawing cash from it, or using it to pay policy premiums.

Pros

• Beneficiaries receive a death benefit: Cash value life insurance is a permanent life insurance policy, which means it can remain in effect until the holder dies as long as the premiums are paid.
• Participating life insurance policies have dividends: Many whole life insurance policies are "participating," meaning the policyholder can potentially get life insurance dividends if the policy is from a mutual insurance company. Dividends can be taken as cash, added to the cash value, used to pay premiums, or used to buy "paid-up additions" that increase the death benefit amount.
• Extra coverage can be added with riders: One of the most common life insurance riders is an accelerated death benefit, which is often automatically included at no extra charge. Similar riders—but with an extra charge—for chronic illness, critical illness, and long-term care let the policyholder tap into their own death benefit if they develop certain medical conditions.
• Tax advantages: The cash value accumulates on a tax-deferred basis. So as the cash value grows, the IRS doesn’t take a cut. Also, if the policyholder borrows money against the policy, they won’t have to pay taxes on the loan. When the policyholder passes away, their beneficiaries receive the death benefit tax-free, as with all life insurance payouts.

Cons

• Cost: Cash value life insurance costs more than term life insurance. If the policyholder doesn't need insurance for their entire life and isn't interested in building cash value, term life insurance will provide the most coverage for their money.
• Time to build cash value: Cash value can take time to build. Some policies take a long time to build up any significant cash value. The policyholder could wait many years before they have a substantial amount to access.
• Cash value is typically not paid to beneficiaries: When the policyholder passes away, the cash value typically reverts to the life insurance company. The beneficiaries receive the policy’s death benefit amount minus any loans and withdrawals from the cash value made by the policyholder.
• Policy could lapse: If the policyholder borrows too much or doesn't maintain a minimal cash value level, their policy could lapse.
• Taxes may apply: If the policyholder withdraws cash value or takes the surrender value and terminates the policy, they may be taxed on the portion of the money that came from interest or investment gains.

Whole life insurance

• Withdraw or take a loan on the cash value: Policyholders can tap into the cash value to pay for major expenses, such as college, a down payment on a house, an emergency fund, or retirement income. They can opt to receive regular payments from the policy's cash value, which may be tax-free. However, taking out a loan against the policy may cause the contract to lapse if the cash value is not maintained, and it will reduce the death benefit for heirs.
• Create generational wealth: Whole life insurance can be used as part of an estate plan to help heirs navigate federal estate taxes, which can reduce inheritance by up to 40%. Creating an irrevocable life insurance trust (ILIT) allows death benefit proceeds from a whole life insurance policy to pass to heirs outside of the taxable estate, preserving wealth for future generations.
• Collect dividends: Some whole life insurance policies offer dividends, which can be credited towards premiums, paid out directly, used to earn interest, or used to purchase paid-up additional insurance to increase the contract's cash value and death benefit.
• Surrender the policy: If the policy is no longer needed, it can be surrendered to receive the accumulated cash value, minus any fees and outstanding loan balances. However, this may create a taxable event, and the policyholder should consider the consequences of giving up the death benefit.

While whole life insurance offers benefits such as guaranteed returns and stable premiums, it may not be suitable for everyone. The premiums are typically higher than those of term life insurance, and the cash value can be slow to grow. Additionally, policyholders cannot control their investment portfolio, as the insurance company chooses where to invest the cash value portion.

Universal life insurance

Flexible Premium Payments

One of the key advantages of universal life insurance is its flexibility when it comes to premium payments. Policyholders can choose how much they pay and when they pay, as long as the payments cover the cost of insurance. This flexibility can be beneficial for those with fluctuating incomes or variable financial circumstances.

Cash Value Accumulation

Adjustable Death Benefit

Comparison with Whole Life Insurance

While both universal and whole life insurance provide lifelong coverage and build cash value, there are some key differences. Whole life insurance has fixed premiums and a guaranteed death benefit, whereas universal life insurance offers flexible premiums and a flexible death benefit. Whole life insurance premiums are typically higher due to the fixed nature of the policy. Additionally, whole life insurance policies may pay dividends, while universal life insurance policies do not.

Considerations

It's important to carefully consider the potential risks and drawbacks of universal life insurance. The cash value can be affected by underperformance of investments or underpayment of premiums, which could impact the death benefit or even cause the policy to lapse. Additionally, some withdrawals from the cash value may be subject to taxes. Therefore, it's crucial to monitor the cash value and ensure sufficient funds are available to cover the cost of insurance.

Variable life insurance

The unique feature of variable life insurance is that its cash component can be invested in asset options, mainly mutual funds. The value of the account will depend on the premiums paid, how the investments perform, and the associated fees and expenses. The cash value component can be accessed for other purposes, such as paying for a major expense.

Frequently asked questions