Life Insurance's Cash Accumulation: How Does It Work?

Cash accumulation life insurance is a type of permanent life insurance that includes a savings feature. A portion of the premium payment goes into an account that collects interest over time. This cash value can be used to make premium payments, borrow money, or withdraw cash. The cash value component serves as a living benefit for policyholders, who can use it for many purposes, such as getting a loan, accessing cash, or paying insurance premiums. The death benefit provides cash to beneficiaries when the policyholder dies, and the cash value can be used to help fund children's college education, supplement retirement income, or assist with a down payment on a home.

Cash accumulation methods

Cash accumulation life insurance, also known as permanent life insurance, includes a cash component in addition to a death benefit. This cash component is intended to help protect your loved ones from financial strain in the event of your death.

Step 1: Equate the premiums paid for the policies

If one policy's premium is more than the other, the difference between the two is placed in a side fund. For example, if Policy A has a premium of $1,000 and Policy B has a premium of $200, then $800 is placed in the side fund.

Step 2: Accumulate the side fund at an assumed rate of interest

The difference in premiums (the side fund) is accumulated at a specified interest rate, commonly 6%. So, if the side fund is $800 and the interest rate is 6%, the amount in the side fund in Year 1 is $848.

Step 3: Change the face amount of the policy with the lower premium

The face amount of the policy with the lower premium is adjusted so that the sum of the side fund and the face amount of that policy equals the face amount of the policy with the higher premium. For example, if the original face amount of Policies A and B is $100,000, the face amount of Policy B is changed to $99,152 so that the sum of the side fund ($848) and the face amount equals the face amount of Policy A.

Step 4: Compare the cash value of the policies over a period of years

Compare the cash value of the policy with the higher premium to the side fund balance of the policy with the lower premium over a period of years to determine which is the better value. For example, if the side fund value of Policy B is more than the cash value of Policy A until Year 10, when the cash value of Policy A exceeds the side fund value of Policy B, then Policy A may be a better value if you plan to keep the policy for more than 10 years.

The cash accumulation method is a useful way to compare the cost-effectiveness of different cash value life insurance policies, especially when comparing term insurance with permanent insurance. However, it is important to note that the results may be misleading if the information inputted is not accurate, such as choosing an unrealistic interest rate.

Premium payments

Cash accumulation life insurance, also known as permanent life insurance, includes a death benefit and a cash component. The cash component is intended to be a tool to help protect your loved ones from financial strain in the event of your death.

When you make premium payments on a cash value life insurance policy, one portion of the payment is allotted to the policy’s death benefit (based on your age, health, and other underwriting factors). Another portion covers the insurance company’s operating costs and profits. The rest of the premium payment goes toward your policy’s cash value.

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 you earn within a cash value policy can be fixed, as in the case with whole life insurance, or it can depend on how premium payments are invested, as in the case with universal life insurance.

Once you've begun accumulating cash value in a life insurance policy, you can use these funds to pay your policy premium, take out a loan at a lower rate than banks offer, create an investment portfolio that maintains and accumulates wealth, or supplement retirement income.

In the early years of the policy, a higher percentage of your premium goes toward the cash value. Over time, the amount allotted to cash value decreases. Each year, as you grow older, the cost of insuring your life gets more expensive for the life insurance company. This is why the older you are, the more it costs to purchase a new life insurance policy of any type. When it comes to cash value insurance, the insurance company factors in these increasing costs.

Your cash value balance also grows by the return offered by your type of policy. The larger your balance, the more it can earn. You typically have a larger balance as you get older because you've had the policy for longer, which leads to larger earnings. Whether this is enough to outweigh the higher insurance costs depends on your individual policy.

Your insurer can give you a life insurance illustration predicting your cash value accumulation over time. That way, you can see the expected result before signing up.

Cash value withdrawal

Cash accumulation life insurance, also known as permanent life insurance, includes a cash component in addition to a death benefit. This cash component can be used to help protect your loved ones from financial strain in the event of your death.

Surrender

One option is to cancel the policy entirely and take the surrender value cash payment. However, with this option, you will no longer have life insurance coverage, and the cash you receive will be lowered by any fees taken out. Surrender fees can be significant, especially with a newer policy. Surrendering a policy before retirement age should be considered a last resort, especially if you don’t have other life insurance in place.

Withdrawal

In many situations, you can take a cash withdrawal from your permanent life policy, and that money is often not subject to income taxes as long as it’s not more than the amount you’ve paid into the policy. However, your death benefit will likely be reduced, depending on the value of your cash account, and that reduction may be greater than the amount withdrawn, depending on the specific terms of your policy. Talk to your agent or life insurance company to find out how withdrawing money from your specific policy works.

Loans

You can typically borrow money through your policy, although the amount varies. The money does not actually come from your policy but rather from the insurer who then uses your policy as collateral. Life insurance loans include interest payments, but it’s typically a lower rate than you’d get with personal loans or even a home equity loan. There’s no loan application or credit check, and credit rating does not impact your interest rate. You can choose not to repay, but the outstanding loan balance will typically be deducted from your death benefit. A policy loan can be a helpful option if you momentarily need cash but want to keep the full death benefit in force by repaying the loan amount.

Use cash value to pay your life insurance premium

You can typically use the money in your cash value to pay part or all of your policy premiums, making it easier to keep your coverage in place. This is a popular option for older policyholders who want to use retirement income for living expenses but still want to keep life insurance coverage in place.

Cash value vs surrender value

Cash accumulation life insurance, also known as permanent life insurance, is a type of insurance that includes a cash component in addition to a death benefit. This cash component is intended to help protect your loved ones from financial strain in the event of your death. The cash value component can function in a variety of permanent plans, including whole, universal, variable, and indexed life insurance.

Now, let's delve into the differences between cash value and surrender value in a life insurance policy.

Cash Value vs. Surrender Value:

Cash value and surrender value are two distinct concepts in life insurance that are important to understand, especially when considering early cancellation of a policy. Here's a detailed explanation:

Cash Value:

Cash value is the sum of money that accumulates in a permanent life insurance policy or a cash-value-generating annuity over time. It is a feature unique to permanent life insurance policies, such as whole life or universal life, and is not applicable to term life insurance. The cash value component serves as a living benefit for policyholders, allowing them to access funds during their lifetime. Policyholders can use the cash value for various purposes, such as taking out loans, accessing cash, or paying insurance premiums. The cash value grows as a portion of the premium payments are allocated to this account, and it can earn interest or investment returns.

Surrender Value:

Surrender value, on the other hand, is the actual amount of money a policyholder will receive if they choose to withdraw all of the policy's cash value by cancelling the policy early. It is important to note that surrender fees or charges may be deducted from the cash value, resulting in a lower surrender value. These fees are designed to discourage policyholders from cancelling their policies prematurely. In most cases, surrender fees are no longer applicable after a certain period, typically 10 to 15 years, at which point the cash value and surrender value become the same.

When considering accessing the cash value of a life insurance policy, it is essential to understand the potential impact on the death benefit, as withdrawals or loans against the policy may reduce the total benefit for your beneficiaries.

Whole life insurance

The cash value of whole life insurance can be accessed in several ways. The policyholder may be able to take out a loan against the policy, surrender the policy, or make a withdrawal. Accessing the cash value in the policy will reduce the available cash surrender value and the death benefit.

The cash value of whole life insurance policies can be used to pay for a range of expenses. For example, the cash value can be used to pay for a child's college education, cover a medical emergency, or provide an additional source of retirement income. The cash value can also be borrowed against to buy a house or pay for a child's college costs, all on a tax-free basis.

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. Policyholders can pay higher premiums for fewer years or lower premiums for more years. The policy's cash value can be accessed during the lifetime of the policyholder through loans or by surrendering any paid-up additional insurance.

Frequently asked questions