Whole Life Insurance And Cash Value: What's The Difference?

Whole life insurance and cash value insurance are both permanent life insurance policies that last for the duration of the holder's life. They also share a savings component, which allows the policyholder to withdraw or borrow cash from the policy. However, the two types of insurance policies are not the same. Whole life insurance policies offer a fixed monthly premium, a fixed rate of growth for the cash value, and a guaranteed death benefit amount. On the other hand, cash value insurance policies encompass multiple types of life insurance policies, including whole life insurance, that contain a cash value account.

Whole life insurance and cash value

Whole life insurance policies have a cash value component, which can be defined as a savings element of the policy. When you pay your premium, a portion of it goes towards funding the policy's cash value. This cash value earns interest over time, and once it has accumulated enough, you can access the money in various ways.

The cash value of whole life insurance policies typically grows at a fixed rate, and policyholders with mutual companies may earn additional dividends. This steady, predictable growth is one of the main attractions of whole life insurance policies.

In summary, whole life insurance is a type of permanent insurance policy that includes a cash value component, which functions as a savings account that can be accessed by the policyholder in various ways. The cash value of the policy grows over time and can be a useful source of funds during the policyholder's lifetime.

Pros and cons of cash value insurance

Cash value life insurance is a permanent life insurance policy that combines a death benefit with a cash accumulation feature. This type of insurance offers several benefits, but also has some potential drawbacks. Here are some pros and cons to help you decide if cash value life insurance is right for you:

Pros of Cash Value Life Insurance:

• Access to funds while living: One of the most significant advantages of cash value life insurance is the ability to access the cash value during your lifetime. This provides a financial safety net for unexpected expenses. You can borrow against the policy's cash value or make partial withdrawals, depending on the type of policy you have.
• Tax-deferred growth: The cash value in your policy grows tax-deferred, which means you don't pay taxes on the interest earned unless you withdraw it. This allows your money to grow faster.
• Fixed or potentially higher returns: Depending on the policy type, you can earn steady interest (whole life) or take advantage of market-linked growth opportunities (variable or indexed policies).
• Premium flexibility: Many policies let you overpay your premiums to build up the cash value faster, giving you more funds to access later.
• Lifelong coverage: Cash value life insurance provides lifelong coverage, meaning it lasts your entire life as long as premiums are paid. This gives peace of mind that your loved ones will receive a death benefit payout regardless of when you pass away.

Cons of Cash Value Life Insurance:

• Higher premiums: One of the biggest drawbacks of cash value life insurance is the cost. Cash value policies tend to have significantly higher premiums than term life insurance policies, so it's essential to consider if the added cost fits your long-term budget.
• Fees and expenses: Cash value policies often come with extra fees and charges, especially in the early years, which can impact the growth of your cash value.
• Potential impact on the death benefit: Withdrawals or unpaid loans from your cash value can reduce the death benefit left to your beneficiaries. Therefore, accessing your cash value has trade-offs that should be carefully considered.
• Slow accumulation: Building up a substantial cash value can take several years, so it may not offer immediate financial benefits.
• Complex structure: Cash value policies are more complicated than straightforward term policies, so understanding the specifics of your policy is crucial for effective management.

How cash value insurance works

Cash value life insurance is a permanent life insurance policy that lasts for the lifetime of the holder. It features a cash value savings component, which the policyholder can use for several purposes, including borrowing or withdrawing cash from it, or using it to pay policy premiums.

When you make a premium payment for cash value life insurance, it is allocated in three ways: into the policy's cash value, to the insurer's cost of providing the death benefit, and toward the insurance company's fees and charges. Only a portion of what you pay winds up in the cash value account, and this grows based on a fixed amount and/or investment gains.

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

There are several ways to access the cash value of your life insurance policy. Partial withdrawals are usually permissible, although these reduce the death benefit. Some policies allow unlimited withdrawals, while others restrict the number of withdrawals per term or calendar year. Most cash value life insurance arrangements also allow for policy loans, which will be charged interest by the issuer. The outstanding loan amount will reduce the death benefit if the policyholder dies before the loan is fully repaid.

Types of cash value insurance

Cash value life insurance is a type of permanent policy that can build funds over time through the cash value component. Cash value can function in a variety of permanent plans, including whole, universal, variable, and indexed life insurance.

Whole Life Insurance

Whole life insurance is a type of permanent insurance that lasts the entire life of the policyholder, with premiums being paid regularly. Whole life insurance is also referred to as "ordinary life" or "straight life". The cash value of whole life insurance can still grow with potential tax savings, and the death benefit is guaranteed as long as the premiums are paid. The premiums in this type of plan are usually fixed and depend on your age at the time you buy.

Universal Life Insurance

Universal life insurance, also referred to as "flexible premium adjustable life insurance", features a savings element (cash value) that grows on a tax-deferred basis. The insurer invests a portion of your premiums, and the return on the investment is credited to your policy tax-deferred. Universal life insurance offers a guaranteed minimum interest rate, which means the insurer guarantees a certain minimum return on your money. Many universal life policies offer a no-lapse guarantee, which means that as long as you pay the minimum premium, the policy will stay in force until maturity.

Variable Life Insurance

Variable life insurance is a permanent life insurance policy with an investment component. The death benefit and cash values vary depending on the performance of the investments chosen. This type of plan tends to involve more risk, as the cash value will grow or diminish based on the performance of the chosen investments.

Indexed Life Insurance

An indexed life insurance plan has a greater relationship with the stock market, as this is used to determine growth. The rate of return on the cash value within the policy is directly impacted by the performance of the chosen index. While there is a certain level of risk involved in an indexed universal life insurance plan, you can typically still secure a guaranteed minimum interest rate.

Accessing cash value

Accessing the cash value of a whole life insurance policy can be done in several ways, each with its own pros and cons. Here is a detailed look at the various methods:

Partial Withdrawals

Policyholders can make partial withdrawals from their whole life insurance policy. This option provides flexibility in accessing funds for various needs. However, it is important to note that any withdrawals will reduce the life insurance death benefit, which is the payment made to the beneficiary upon the policyholder's death.

Borrowing Against the Cash Value

Another option is to take out a loan against the cash value of the policy. This allows policyholders to borrow money for any purpose they wish. However, these loans typically need to be repaid with interest. If the loan is not repaid before the policyholder's death, the outstanding loan amount will be subtracted from the death benefit paid to the beneficiary.

Surrender the Policy

Policyholders can also choose to withdraw all the cash value and surrender their whole life insurance policy. This option provides access to a large portion of the cash value. However, it is important to note that this will end the life insurance coverage, and there may be surrender fees or taxes applicable.

Using Cash Value to Pay Premiums

In some cases, the cash value of a whole life insurance policy can be used to pay the premiums or the cost of insurance. This option can be helpful for policyholders who wish to reduce their monthly expenses while retaining their coverage. However, using the cash value to pay premiums may impact the value of the death benefit over time.

Selling the Policy

Policyholders also have the option to sell their whole life insurance policy to a third party for more than the cash surrender value but less than the death benefit. This option allows policyholders to access a significant portion of their cash value. However, it is important to note that selling the policy will result in the loss of life insurance coverage, and there may be taxes and fees applicable.

Weighing the Options

The various methods for accessing the cash value of a whole life insurance policy offer different benefits and considerations. It is important for policyholders to carefully weigh their options and consider the impact of each method on the death benefit, account growth, and any applicable taxes or fees. Consulting a financial advisor can help policyholders understand the potential consequences of each option and make an informed decision.

Frequently asked questions