Is Cash Value Life Insurance Beneficial For Small Businesses?

Cash value life insurance is a type of permanent life insurance that features a cash value savings component. This means that the policyholder can borrow or withdraw cash from the policy, or use it to pay policy premiums. The cash value of a life insurance policy grows tax-deferred, and the money can be accessed during the policyholder's lifetime. However, withdrawing money from the policy will reduce the death benefit for beneficiaries. Cash value life insurance is more expensive than term life insurance and may not be the best option for those who don't need lifetime coverage or want to maximise their returns.

Pros and cons of cash value life insurance

Cash value life insurance is a permanent life insurance policy that lasts a lifetime and includes a savings or investment account. This savings component is called the cash value, and it grows over time. The cash value can be borrowed against or withdrawn while the policyholder is alive, but doing so will decrease the death benefit paid out to beneficiaries.

Pros

• The cash value grows tax-deferred, and withdrawals of premiums (not gains) are tax-free.
• The policyholder can borrow or withdraw cash from the policy, per the policy rules.
• The cash value can be used to pay premiums, per the policy rules.
• The policy lasts the entire life of the policyholder.
• The cash value can be used as a living benefit, providing financial protection for loved ones after the policyholder's death.
• Policyholders can benefit from dividends and add riders for extra coverage.

Cons

• It takes time to accumulate cash value, and the cash value doesn't go to beneficiaries.
• Borrowing and withdrawing from the cash value may decrease the death benefit.
• The policyholder will pay interest on cash value loans.
• Cash value life insurance is more expensive than term life insurance.
• Managing the policy may require a hands-on approach.
• The cash value may not build up quickly and could take years to reach a substantial amount.
• The cash value of some policies will revert to the insurance company upon the policyholder's death.

Whole life insurance

• Guaranteed returns and coverage: Whole life insurance provides permanent coverage and guarantees returns on your cash value. It is an excellent option for those seeking stable and predictable long-term returns from a tax-advantaged investment.
• High premiums: The cost of whole life insurance is usually much higher than term life insurance. The high premiums may not be worth it if you only need life insurance for a specific period or have a limited budget.
• Slow cash value growth: In the initial years of a whole life insurance policy, a significant portion of your premiums goes towards fees and administrative costs. It can take a decade or more to build enough cash value to borrow against or utilize in other ways.
• Low rate of return: The average annual rate of return on the cash value for whole life insurance is between 1% to 3.5%, which may be lower than what you could achieve with other investments.
• Limited investment control: Insurance companies invest your cash value and declare the dividend or interest rate. If you are an experienced investor, you may prefer to have more control over your investment choices.
• Tax implications: Withdrawing cash from your policy or surrendering it may have tax consequences. Generally, you pay taxes only on the amount that exceeds your policy basis (total premiums paid minus dividends received).
• Ideal for specific situations: Whole life insurance is worth considering if you want to provide a death benefit to beneficiaries regardless of when you die, seek conservative investments with stable returns, have maxed out retirement accounts, or want to tap into the cash value during your lifetime.

Universal life insurance

There are a few types of universal life insurance, including guaranteed universal life, indexed universal life, and variable universal life. Guaranteed universal life insurance offers a death benefit and premium payments that will not change over time. You’ll generally select an age at which the policy ends (such as age 90, 95, 100, 105, 110, or 121). Indexed universal life insurance (IUL) offers lifelong coverage and has flexibility with the death benefit and premiums. The cash value component in IUL is tied to a stock market index, such as the Nasdaq-100, S&P 500, or a combination of indexes. Variable universal life insurance allows you to vary premium payments and the death benefit amount, within limits. You’ll generally need to actively manage this kind of policy because you’ll select sub-accounts for your cash value investments.

The main perk of universal life insurance is the ability to adjust your premiums. You can pay more than the minimum premium, up to a certain limit, and the additional funds—minus any administrative charges—are funnelled into your cash value. Alternatively, you can pay less than the minimum premium. But you must have sufficient cash value to cover the cost of insurance and other expense charges, or your coverage may lapse.

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 your account will depend on the premiums you pay, how your investments perform, and the associated fees and expenses. You can also allocate money towards a fixed account to receive a fixed rate of interest and reduce overall risk. This rate may change annually, but there is typically a guaranteed minimum, such as 3%.

When is cash value life insurance worth it?

Cash value life insurance is a permanent life insurance policy that lasts a lifetime and includes a savings or investment account. It is more expensive than term life insurance, and the cash value typically reverts to the insurance company upon the policyholder's death. However, it can be worth it in certain situations.

Cash value life insurance can be worth it if you want long-term coverage and access to savings later in life. It is also a good option if you want to provide financial protection for your loved ones after your death and have access to a cash reserve while you are alive.

If you are looking to build a nest egg over several decades, cash value life insurance can be a good savings option, alongside a retirement plan like an IRA or 401(k). It is important to note that cash values often take a few years to start accruing, and you may have to pay a penalty if you want to access the cash value early.

Another situation where cash value life insurance can be beneficial is when you want to combine the benefit of permanent coverage with the ability to access the accumulated cash value during your lifetime. This can be useful if you need to supplement your retirement income, pay for long-term care, or cover other expenses.

Additionally, cash value life insurance can be a good investment option if you are looking for tax advantages. The cash value accumulates on a tax-deferred basis, and you don't have to pay taxes on any loans you take out against the policy.

However, it is important to consider the downsides of cash value life insurance. It can take a long time to build up a significant cash value, and the cash value of some policies will revert to the insurance company upon your death, rather than going to your beneficiaries. Additionally, the returns on the investment portion of cash value life insurance are often lower compared to other types of investments, such as stocks or mutual funds.

Frequently asked questions