Understanding Life Insurance: Unlocking Account Value

Life insurance can be a complex product with a web of terms and numbers. One of the key values in a life insurance policy is the account value, which is the total amount of money accumulated in the policy after premiums have been paid and interest has been credited, minus any withdrawals, loans, or charges. This is also referred to as the cash value, and it reflects the total sum of money in a cash-value-generating annuity or permanent life insurance policy.

Accumulated value

The account value reflects the cash value component of the policy, which is essentially the policy's savings account. Part of the premium payments made by the policyholder is allocated to this account, where it is invested and grows on a tax-deferred basis. The insurance company typically manages these investments, which can be invested in a variety of instruments depending on the policy's structure. Over time, the account value can accumulate significant funds, providing multiple benefits to the policyholder.

One advantage of accumulated value is the ability to use it as loan collateral. Policyholders can borrow money against their account value at a reduced interest rate, providing a financial advantage over traditional loans or credit cards. Additionally, the money in the account continues to grow even when borrowed, allowing policyholders to benefit from compounding interest. This feature makes it a powerful tool for long-term financial planning, as it enables access to funds while maintaining the growth of financial assets.

Another benefit of accumulated value is the option to withdraw funds for personal use. Policyholders can access their accumulated value through policy loans or withdrawals during their lifetime. This flexibility provides financial liquidity and can be useful for various purposes, such as starting a business, funding unexpected expenses, or simply building a financial cushion. However, it is important to note that early withdrawals may incur penalties, and outstanding loans against the policy's accumulated value can reduce the total death benefit.

In summary, the accumulated value in life insurance refers to the total amount of money built up in a policy over time, minus any deductions. This value can be utilised as collateral for loans, accessed for personal use, or allowed to grow as a financial investment. Understanding and maximising the potential of accumulated value is essential for policyholders to leverage the full benefits of their life insurance policies.

Borrowing against account value

Borrowing against your life insurance policy can be a convenient way to access funds without the hassle typically associated with traditional loans. This option is available for permanent life insurance policies, such as whole or universal life insurance, which accumulate a cash value over time. This cash value is essentially the total amount of money in the policy after premiums have been paid and interest has been credited, minus any withdrawals, loans, or charges. Here are some key points to consider regarding borrowing against the account value of your life insurance policy:

Advantages

• No credit checks or approvals: Borrowing from your life insurance policy does not require a credit check or a lengthy approval process. As long as your policy has enough cash value, you can simply request the loan.
• Fast access to funds: With life insurance loans, you can quickly access the money you need without the long waits associated with traditional loans.
• No restrictions on usage: You have the freedom to use the borrowed funds for any purpose, such as starting a business, funding a home renovation, or covering unexpected expenses.
• Lower interest rates: Policy loans typically have lower interest rates compared to loans from banks or other financial institutions.
• Flexible repayment: There is no set repayment schedule, and you can choose to repay the loan at your convenience. Additionally, you have the option to only pay the interest to prevent the loan from eating into your cash value.
• No impact on credit score: Life insurance loans are not reported to credit agencies or the government, so they won't affect your credit score.

Disadvantages

• Interest accumulation: Interest on the loan will accumulate over time, and if left unpaid, it can eventually deplete your policy's cash value.
• Reduced death benefit: If the loan is not repaid before the policyholder's death, the outstanding balance, including interest, will be deducted from the death benefit paid to the beneficiaries.
• Potential policy lapse: If the loan amount, including interest, exceeds the policy's cash value, your coverage may lapse, leaving you without insurance and potentially facing tax penalties.
• Slowed cash value growth: Taking out a loan against your life insurance policy may slow down the growth of your cash value, impacting your long-term financial goals.
• Rider reductions: Borrowing against the policy may reduce the amount available for special features, such as an accelerated death benefit rider.

Process

The process of borrowing against your life insurance policy is straightforward. Contact your insurance agent or company, fill out a basic form, and if your cash value is sufficient, you can expect to receive the funds within a few business days. Remember that interest starts accruing immediately, so it's important to carefully consider your repayment plan.

Surrender value

Types of Surrender Values:

There are two main types of surrender value:

• Guaranteed Surrender Value (GSV): This is the minimum amount a policyholder will receive upon surrendering the policy, subject to certain terms and conditions. The GSV is calculated as a percentage of the total premium payments minus applicable charges.
• Special Surrender Value (SSV): This is a benefit provided by certain policies, offering a higher surrender value than the GSV. The payment of SSV is at the discretion of the insurance company and is based on specific plan details, such as the performance of the funds the policy is invested in, along with any bonuses or interest earned.

Calculating Surrender Value:

The calculation of surrender value depends on several factors:

• Premiums Paid: The total amount of premiums paid towards the policy.
• Policy Term: The period for which the term insurance policy remains active, selected at the time of purchasing the plan.
• Bonuses or Interest: Any bonuses or interest included in the policy that the policyholder is eligible for at the time of surrender.
• Deductions: Surrender charges or penalties imposed by the insurance company on the policy value due to pre-closure.

Pros and Cons of Surrender Value:

Pros:

Flexibility: Surrender value provides flexibility, ensuring that some monetary value can be retrieved even if the plan needs to be ended prematurely.

Cons:

• Loss of Coverage: Surrendering the policy results in the loss of insurance coverage.
• Potential Loss in Return Value: Depending on the plan and investment growth, the surrender value might be lower than the cumulative amounts paid in premiums.

Factors Affecting Surrender Value Calculation:

• Types and Features of Policies: The type of insurance policy chosen heavily influences the surrender value calculation.
• Duration of the Policy: Longer policy terms generally result in higher surrender values due to increased accrued value.
• Accumulated Policy Value: The total value of the policy, including premiums paid, interest earned, and additional benefits, forms the foundation for surrender value calculation.
• Accumulated Bonuses: Bonuses declared over the course of the policy, whether in cash or added benefits, enhance the surrender value.
• Higher Premium Payments: Higher premiums paid result in a higher surrender value.
• Age of the Insured: Initiating a life insurance policy at a younger age often leads to a higher surrender value due to the extended policy duration.
• Current Market Conditions: Current market dynamics, including economic factors, interest rates, and investment performance, can impact the overall value of the policy over time.

Important Considerations:

• Surrender Fees: Some policies may impose surrender fees, directly impacting the amount received upon surrender.
• Timing of Surrender: Correctly timing the surrender by considering market conditions, policy accumulation, and bonus declarations will maximise the surrender value.
• Tax Implications: Surrender values are generally not tax-free. Life insurance funds may be considered 'income from other sources' and may be subject to taxation.

Policy loans and withdrawals

Withdrawals

When a policyholder makes a withdrawal, they are directly taking money out of their policy. This will always reduce the cash value of the policy. The impact of a withdrawal will depend on the type of policy. For example, a withdrawal from a universal life insurance policy will reduce the accumulated cash value and the interest that will be earned in the future. On the other hand, a withdrawal from a whole life insurance policy will reduce the face value of the policy and adversely affect any future dividends.

It is important to note that a withdrawal may trigger a tax liability. If the withdrawal amount is greater than the cost basis (the premiums paid for the policy), then the amount over the cost basis will be considered income for the year of the withdrawal.

Loans

Policy loans, on the other hand, are provided by the insurance carrier using the cash value and death benefit of the policy as collateral. The policyholder does not need to go through an approval process and there is no credit check. The loan amount depends on the policy's terms and conditions and can often be up to 90-95% of the policy's cash value.

Policy loans can have either a fixed or variable interest rate, depending on the type of policy. With a fixed-rate loan, the interest rate is declared in advance and remains the same throughout the life of the loan. Variable-rate loans have a floating interest rate that is determined by the insurance company and occasionally adjusted.

It is important to consider the potential impact of a policy loan on the growth of the policy's cash value over time, as well as the interest paid on the loan. While the policyholder is not required to repay the loan, failure to do so will result in the loan amount being deducted from the death benefit. Additionally, if the loan value exceeds the cash value of the policy, the policy could be terminated by the insurance company.

Comparison

Both policy loans and withdrawals can provide access to the cash value of a life insurance policy. However, it is important to understand the potential implications of each option. Withdrawals will always reduce the cash value of the policy, while policy loans use the cash value as collateral and may have more flexible repayment options. Policy loans may also have more favourable interest rates compared to traditional bank loans.

It is recommended to consult with a financial advisor or tax professional before making any decisions regarding policy loans or withdrawals to fully understand the potential benefits and risks.

Death benefit

A death benefit is the primary reason for purchasing a life insurance policy. It is the amount of money paid to the beneficiary (the person you choose to give the money to) when the policyholder (insured person) dies. This money is typically tax-free and can be paid out all at once or over time.

When you buy a life insurance policy, you select a death benefit and name a beneficiary who will receive the payout. For example, if you buy a life insurance policy with a $100,000 death benefit and pass away, the insurance company will pay $100,000 to the person you named as your beneficiary. This money can help provide financial support to your loved ones.

There are two main types of death benefits:

• Accidental death benefit: This only pays out if the insured person dies due to a qualifying accident listed in the policy.
• All-cause death benefit: This pays out regardless of how the insured person dies, unless the cause of death is specifically excluded from the policy.

The death benefit can be paid out in a few different ways:

• Lump-sum: This is the most common payout option where the entire death benefit is paid at one time.
• Installment: The death benefit is paid out in installments over a specified period of time.
• Annuity: The death benefit is converted into an annuity, which then makes regular payments over a certain period or for the lifetime of the beneficiary.
• Retained Asset Account: The insurance company retains the death benefit but gives the beneficiary check-writing privileges to draw from the payout.

It is important to note that if you borrow from your policy's cash value and don't repay the loan before you die, the amount you owe will be taken out of your death benefit. Additionally, if your policy expires before you die, your beneficiaries won't receive a death benefit unless you purchase another policy that is in effect when you pass away.

Frequently asked questions