Understanding Life Insurance: Quick Cash Value Build Strategies

Cash value life insurance is a type of permanent life insurance that includes a cash value feature. This means that, in addition to the death benefit, there is a cash component that can be used to protect your loved ones from financial strain. Cash value life insurance policies provide lifelong coverage combined with an investment account. Each time you make a premium payment, the money is split into three categories: the cost of insurance, fees and overheads, and the cash value. 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.

Premium payments are split into three categories

The death benefit is based on your age, health, and other underwriting factors. The insurer's costs include operating costs and profits. The cash value portion of your premium payment is deposited into an interest-bearing savings account, where it grows over time. This cash value component serves as a living benefit for policyholders, who may access these funds for various purposes during their lifetime.

In most cases, cash value doesn't accrue for two to five years. The life insurance company generally invests this money in a conservative-yield investment. As you continue to pay premiums on the policy and earn more interest, the cash value grows over the years.

The rate of return on a cash value policy depends on the type of policy. For example, the rate of return is fixed in the case of whole life insurance, while it depends on how premium payments are invested in the case of universal life insurance.

As you get older, the cost of insuring your life increases, so the older you are, the more it costs to purchase a new life insurance policy. This is reflected in cash value insurance policies, where the portion of premium payments allocated to the cash value account decreases over time.

Cash value accumulation varies by policy

Whole Life Insurance

Whole life insurance offers a fixed monthly premium, a fixed rate of growth for your cash value and a guaranteed death benefit amount. Because of these guarantees, whole life insurance is typically more expensive than other life insurance options. Whole life insurance builds cash value, an asset that can be used to help pay for a child's college, cover a medical emergency, or serve as an additional source of retirement income. The cash value growth in a whole life policy is guaranteed and grows tax-deferred. Dividends, if declared, may increase the cash value growth even more.

Guaranteed Issue Life Insurance

This is a type of whole life insurance that doesn’t require a medical exam or health questions. You cannot be turned down. Guaranteed issue life insurance may include cash value, but since coverage amounts are generally small, the potential cash value is small. It usually has a graded death benefit where beneficiaries won’t receive the full payout if the insured person passes away within two or three years of buying the policy, unless the death was due to an accident.

Guaranteed Universal Life Insurance

This type of universal life insurance has fixed premium and death benefit amounts, and usually minimal cash value accumulation.

Indexed Universal Life Insurance

Indexed universal life insurance connects cash value growth to gains and losses in an index like the S&P 500. You can typically adjust premiums and death benefits within certain parameters.

Variable Universal Life Insurance

With variable universal life insurance, your cash value growth is tied to sub-accounts containing investments of your choice, usually bonds and mutual funds. But you could lose money in the cash value based on the performance of the investments you choose. You can generally adjust your premium and death benefits within set limits.

Borrowing against cash value

When borrowing against the cash value of a life insurance policy, there is no approval process or credit check, and the money can be used for anything, from bills to vacations to financial emergencies. The loan is also not recognised by the IRS as income and remains tax-free as long as the policy stays active. However, it is important to note that the loan must be paid back with interest, and there is no mandatory monthly payment.

The maximum amount that can be borrowed against a life insurance policy is typically up to 90% of its cash value. It is important to continue paying the regular premium payments on time to avoid a lapse in life insurance coverage. If the loan is not paid back, interest is added to the balance, and the policy may lapse. In this case, taxes may be owed on the borrowed amount.

Additionally, borrowing against the cash value of a life insurance policy can reduce the death benefit. If the insured person passes away before the loan is repaid, the loan amount and any interest owed will be deducted from the death benefit, reducing the amount received by the beneficiaries.

Before borrowing against the cash value of a life insurance policy, it is important to consider the potential risks, such as reducing the death benefit and the possibility of paying more in premiums if the cash value is depleted. Consulting a financial advisor can help individuals understand the tax implications and risks associated with borrowing against the cash value of a life insurance policy.

Withdrawing cash value

Understanding Cash Value in Life Insurance

Cash value is a feature typically offered within permanent life insurance policies, such as whole life and universal life insurance. This component acts as a savings account, allowing the policyholder to accumulate cash over time. The cash value grows based on a fixed amount, investment gains, or a combination of both, depending on the policy type. It's important to note that term life insurance, which is for a set period, does not build cash value.

While the specifics may vary depending on the insurance company and policy type, there are generally four common methods for withdrawing cash value from a life insurance policy:

• Partial Withdrawal: You can withdraw a portion of the cash value from your policy. This option is often tax-free up to the amount you've paid into the policy. However, it's important to note that withdrawals may reduce your death benefit, and there could be potential tax consequences if the withdrawal exceeds your basis in the policy.
• Full Withdrawal: It is possible to withdraw the entire cash value and terminate the policy, known as surrendering the policy. This option will result in losing your life insurance coverage, and there may be surrender fees or taxes applied to the withdrawn amount.
• Policy Loan: You can borrow money from the insurer, using your policy as collateral. Policy loans are typically provided at lower interest rates than traditional loans and don't require credit checks. However, the outstanding loan balance will reduce your death benefit unless it is repaid.
• Premium Payment: The cash value can be used to pay your life insurance premiums, helping to keep your coverage in place. This is a popular option for older policyholders who want to use their retirement income for living expenses while maintaining life insurance.

Factors to Consider

When considering withdrawing cash value from your life insurance policy, it's important to weigh the advantages and potential disadvantages:

• Withdrawing cash can provide immediate funds for various financial needs, such as supplementing retirement income, covering college tuition, or making a down payment on a home.
• Withdrawals may reduce your death benefit, impacting the amount your beneficiaries will receive.
• Withdrawing more than your basis in the policy may have tax implications, and certain policies may have restrictions on the amount and frequency of withdrawals.
• Policy loans provide a convenient way to access cash without a credit check, but the outstanding loan balance will accrue interest and reduce your death benefit if not repaid.
• Surrendering the policy for a full cash withdrawal will result in losing your life insurance coverage, and there may be significant fees and taxes applied.

Seeking Professional Advice

Cash value as a tax-free investment

Cash value life insurance is a form of permanent life insurance that features a death benefit and a savings component. The policyholder can use the cash value for many purposes, including borrowing or withdrawing cash from it, or using it to pay policy premiums. Permanent life insurance policies such as whole life, universal life, and variable universal life insurance can accumulate cash value over time.

Cash value accumulates in your permanent life insurance policy because your premiums are split into three categories. One portion of your premium goes towards the death benefit, another goes towards the insurer's costs and profits, and the third contributes to the policy's cash value. In the early years of the policy, a higher percentage of your premium goes towards the cash value. Over time, the amount allotted to cash value decreases, and more of the premium is applied to the cost of insurance.

The rate of return you earn within a cash value policy can be fixed, as in the case of whole life insurance, or it can depend on how premium payments are invested, as in the case of universal life insurance. Cash value can accumulate at different rates depending on how the policy works and market conditions. For example, cash value in whole life insurance builds at a fixed rate, while the cash value in universal life insurance is invested, and the rate of increase depends on how well those investments perform.

You can access the cash value in your policy in several ways:

• Withdrawals: You can withdraw cash from the policy, but this will reduce the death benefit. Withdrawals before the age of 59.5 may be subject to a 10% tax penalty.
• Loans: You can take out a loan against the cash value of the policy. You won't have to pay taxes as long as the policy is maintained, but you may have to pay taxes if the policy ends before the loan is repaid.
• Surrender: If you surrender the policy, you can receive the cash surrender value, which is the total cash value minus any loans and surrender fees.
• Premium payments: If you build up enough cash value, you may be able to use it to cover premium payments.

Tax implications of cash value life insurance

The cash value of life insurance grows tax-free, and you can withdraw up to the amount of the total premiums paid without paying taxes. However, if you withdraw more than the amount of the premiums (i.e., any gains or interest), you will be taxed on that portion as ordinary income. Additionally, if you take out a loan on the policy and the policy terminates before it is repaid, you may be taxed on the loan amount.

While cash value life insurance offers tax advantages, it is important to note that it is more expensive than term life insurance and may take time to build significant cash value.

Frequently asked questions