Life Insurance: Cash Accumulation Funds Explained

Life insurance is typically taken out to provide financial support to loved ones in the event of the policyholder's death. However, some life insurance policies can also be used to build cash value over time, providing access to cash value while the policyholder is still alive. This type of permanent life insurance is known as cash value life insurance or cash accumulation life insurance. It combines a death benefit with a savings vehicle, allowing policyholders to accumulate cash that can be accessed through loans, withdrawals, or surrender of the policy. Whole life insurance and variable universal life insurance are two common types of permanent life insurance policies that offer cash accumulation features.

Whole life insurance

The cash value in a whole life insurance policy can be accessed by the policyholder at any time through a loan or direct withdrawal. Interest will continue to accumulate on the full amount of the cash value, even if only a portion is borrowed. While there is typically a small amount of interest charged on the outstanding balance of a loan from the cash value of a whole life insurance policy, it is generally less than that of a bank, credit card, or other type of personal loan interest. Additionally, the loan balance does not need to be repaid during the lifetime of the insured.

Variable universal life insurance

VUL policies allow you to invest and grow the cash value through subaccounts that operate like mutual funds. Exposure to market fluctuations can generate high returns but may also result in substantial losses. The primary advantage of VUL policies stems from participation in equity or debt markets, which over time may outperform fixed rates determined by the insurance company. Compared to whole life policies that may credit premiums with a 4% interest rate, cash values grow faster in a VUL equity portfolio that annually averages a 7% return over the life of the policy.

VUL is similar to variable life insurance, but it allows you to change your premium payment amount. While VUL insurance offers increased flexibility and growth potential over other life insurance options, you should carefully assess the risks before purchasing it. VUL could make sense if you want permanent life insurance protection, have a higher risk tolerance for investing, and prefer managing investments yourself. It could be worth considering if you've maxed out your other retirement accounts.

The New York Life Variable Universal Life Accumulator II policy and the Market Wealth Plus policy are two examples of VUL policies.

Tax advantages

Permanent life insurance policies, such as whole life insurance and variable universal life insurance, offer the prospect of reasonable cash value accumulation. Whole life insurance includes a cash value account, which grows through tax-deferment. This means that there is no tax due on gains unless or until the money is withdrawn. Whole life insurance is also designed to pay an income tax-free death benefit to beneficiaries.

Whole life insurance policies are typically among the most expensive to purchase. In the initial years, the cash component of a whole life insurance policy grows slowly, as the premium payments go towards paying the insurer's expenses. However, the value can snowball over time due to compound growth, particularly given its tax-advantaged nature. Eventually, the cash value can grow to a point where the insured can stop making premium payments altogether and instead fund the policy using money from the cash value.

Variable universal life insurance offers the chance to build cash value faster by exposing policyholders to riskier equity and debt markets. The primary advantage of VUL policies stems from participation in equity or debt markets, which over time may outperform the fixed rates determined by the insurance company. For example, compared to whole life policies that may credit premiums with a 4% interest rate, cash values in a VUL equity portfolio may achieve a 7% average annual return over the life of the policy.

An alternative option is to take out a life insurance loan. If you borrow money from the insurance company, the loan will be tax-free, and interest will continue to accumulate on the entire cash value of the policy. The loan balance does not necessarily have to be repaid during the borrower's lifetime.

Cash accumulation method

Permanent life insurance policies, such as whole life insurance and variable universal life insurance, help policyholders accumulate cash that can be accessed in retirement or emergencies. Whole life insurance accumulates cash value slowly, while variable universal life insurance offers faster cash value accumulation by exposing policyholders to riskier equity and debt markets.

The cash accumulation method is a technique used to compare the cost-effectiveness of different cash value life insurance policies. It assumes that the death benefits for the policies are equal and unchanging, and the difference in premiums paid is evaluated over a specified timeframe. The policy with the most cash value at the end of the trial period is considered the best.

Let's compare an ordinary life policy (Policy A) with a $1,000 premium and a one-year renewable term policy (Policy B) with a $200 premium. The difference between the premiums, which is $800 in this case, is placed in a side fund. This side fund is then accumulated at a specified interest rate, commonly 6%. After the first year, the side fund will have grown to $848. By repeating this process over the specified timeframe, the total accumulated value for each policy can be calculated and compared.

The cash accumulation method is particularly useful for comparing term insurance with permanent insurance, as it allows for a direct comparison between two policies that are otherwise quite dissimilar. However, it is important to note that the results of this method depend on the accuracy of the inputted information, specifically the interest rate and the term of the policy.

Permanent life insurance

Whole life insurance policies build cash value slowly and it can take several years to reach the point when the total premiums paid equal the cash surrender value of the policy. However, the cash value can be accessed at any time by loan or withdrawal. Variable universal life insurance, on the other hand, offers faster cash value accumulation by exposing policyholders to riskier equity and debt markets. VUL policies participate in equity or debt markets, which over time may outperform fixed rates determined by the insurance company.

The cash accumulation method is a good way to compare term insurance with permanent insurance by equating two dissimilar policies. This method can be used to compare the premiums paid for the policies, with the difference between them placed in a side fund. The amount in the side fund is then accumulated at an assumed rate of interest.

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