How Does Cash Value Life Insurance Work?

Cash value Life insurance products offer everlasting coverage as well as an investing account. A portion of your premiums are directed to the cash value investing account, where the money grows with interest over time. If you opt to cash in your life insurance policy and surrender it to the insurer, you will get the cash value of the policy (minus fees). You can also borrow against the cash value, utilize it to pay premiums, or take a partial withdrawal.

What is cash value life insurance?

Cash value life insurance refers to any life insurance policy that has a death benefit as well as the ability to accrue money in a separate account within the policy. When you make a premium payment, the money is divided into three categories:

• Cost of insurance: the amount required to fund the policy’s death benefit
• Fees and overhead: the operation costs and fees of the insurance firm
• Cash value: the value that accumulates in your policy account.

Because the cash value of a life insurance policy is different from the death benefit, your beneficiaries would not receive the cash value if you died. The insurer keeps any monetary value that remains in your life insurance policy after you die. The cash value of a life insurance policy is essentially the amount of money you would receive if you decided to surrender your coverage or give up the policy to the insurer. The cash value behaves like an investment because it grows tax-free with interest, depending on the type of policy, and it can be used as collateral for a loan.

Even though the growth of the cash value is tax-deferred, it will still take several years of compound interest to rise significantly. Furthermore, the majority of your premiums are eaten up by the cost of insurance and fees for the first three years of coverage, so cash value growth is gradual.

That is why, if you are in your forties or fifties, we normally do not recommend a cash value life insurance policy. The older you get, the more probable it is that the expense of your premiums will outweigh any future gain. Guaranteed universal life insurance provides lifelong coverage with little to no cash value component if you require a permanent life insurance policy to settle estate taxes or leave an inheritance.

Types of cash value life insurance policies

Cash value life insurance policies are normally permanent, which means you get coverage for the rest of your life as long as you pay your payments. The following are some of the most prevalent types of cash value life insurance policies:

There is no cash surrender value with term life insurance contracts. This implies that if you choose to surrender your coverage to the insurer, you will receive nothing in exchange. However, it is also the reason that term life insurance is several times less expensive than cash value life insurance.

With a term life insurance policy, the only time you'd get money back from an insurer is if you have a return of premium rider. This rider raises the cost of your premiums but guarantees that you will receive a portion or the total of premiums paid if you live over the policy's term.

Dividends and participating cash value life insurance policies

Mutual insurance firms have no shareholders and are essentially owned by their policyholders. As a result, if the insurer earns more money than is required to maintain the business, some of it is returned to policyholders in the form of a dividend. If you own a participating cash value life insurance policy, you are entitled for a dividend. Dividends are not guaranteed, but the majority of the biggest mutual insurance firms have distributed them continuously for decades.

Dividends are paid out based on the size of your cash worth. For example, if Jane had $20,000 in cash and John had $10,000 in cash, Jane would receive a dividend that was twice as large as Jon's. Dividends can be taken as cash, used to pay premiums, or used to purchase extra coverage.

What is 7702 life insurance?

Cash value life insurance products are often known as 7702 life insurance. This simply indicates that they are in accordance with Tax Regulation Section 7702. Life insurance policies have a number of tax advantages, such as the death payment given to beneficiaries being tax-free. Section 7702 was enacted to limit the scope of what might be called a life insurance policy and to ensure that other investments did not gain the same tax benefits.

How to access the cash value in your life insurance policy

Premiums for cash value life insurance can be incredibly expensive, it is critical to understand all of the ways you might withdraw funds from your policy. There are several ways to take advantage of your policy's cash value, depending on whether you want to get rid of your coverage and cash out your life insurance or simply take out a loan.

Even if you no longer require coverage, don't let your policy lapse at any time. When an insurance lapses, you lose both the death benefit and any cash value that may have been paid to you.

Pay your premiums with the cash value

Variable and universal life insurance policies are popular because they allow you to pay premiums using the policy's cash value. This method will only work for a limited time if you begin while the cash value is low or interest rates are low. Furthermore, you must carefully check the cash value to ensure that it does not go too low, or you may lose your coverage. However, if you have a somewhat high cash worth with stable returns, you can maintain coverage in place for years at little to no extra cost.

Except when you convert to a paid-up policy, most whole life insurance policies do not allow you to pay premiums using the policy's cash value. Not all insurers provide this option, but the cash value of a paid-up life insurance policy is big enough that you can quit paying premiums out of pocket. The monetary value is used to pay premiums. The disadvantage of fully paid-up whole life insurance policies is that each premium payment is removed from the death benefit. Furthermore, there is less cash value available for other uses, such as a policy loan.

Put up cash value as collateral to borrow from your insurer

A life insurance policy loan is a loan from your insurer that uses the cash value of your policy as collateral. It can be used to cover medical expenditures, purchase a car, or for anything else that requires cash. Because the insurer is holding the funds to cover the loan:

• There are no underwriting requirements
• You can keep the loan outstanding for as long as you want
• There is no credit check, and the loan is not recorded on your credit report.

If you die while the loan is still due, the loan's value will be removed from the death benefit your beneficiaries get.

Borrowing against the cash value of your insurance is simple and often comes with very low yearly interest rates. However, you must either pay interest out of pocket annually or carefully control the quantity of the loan in relation to the cash value of the policy.

If you do not make interest payments, the interest amount is added to the principal balance of the loan. If the entire amount of your loan ever surpasses the cash value of your policy, the policy will lapse, eliminating your coverage. Furthermore, you will almost certainly have to pay income tax on the loan.

Sell your policy for a life insurance settlement

If you want to surrender your policy and cash it in, you should first try to sell it in a life insurance cash settlement. If your premiums are exorbitant and you no longer have dependents, or if they are all financially secure, you may want to consider doing so. A firm buys your life insurance policy for an amount larger than the cash value but less than the death benefit in a life insurance cash settlement. Some businesses will even buy term life insurance policies for cash if you are particularly old or unwell and are expected to die during the policy period.

The settlement will be subject to income and capital gains taxes. Be advised that any brokers that assist you in connecting with a settlement company will normally collect a commission. However, the overall result is that you will usually receive more money than if you surrendered your coverage.

When the policy is sold, the life insurance settlement firm assumes responsibility for premium payments and becomes the policy beneficiary. The disadvantage is that you may not always find a buyer, and the process of being examined by a life insurance settlement business may take several weeks.

Surrender your life insurance policy for its net cash value

If you are unable to obtain a settlement and wish to cash out your life insurance policy, you may surrender it to the insurer. Simply notify your insurer, and they will pay you the net cash value of your life insurance policy.

The net cash value is the policy's "actual" surrender value. It is usually listed individually in your life insurance statements. Because of fees and surrender charges, the net cash value will typically be less than the total accrued cash value for the first several years of coverage. If you've had your policy for 10 to 15 years, the net cash value is likely to be near to or equal to the total accumulated cash value.

Make a partial withdrawal of the cash value

If you don't want to cancel your life insurance but have less financial responsibilities, you can remove a portion of the cash value. This rewards you with cash while decreasing the death benefit of your life insurance policy. For example, if your children have done well in their jobs, you may be less concerned about passing on an inheritance but still want to provide some protection for your spouse.

The following are examples of how a partial withdrawal could function depending on the life insurance policy:

• Variable and universal life insurance policies - A partial withdrawal is the same as obtaining a piece of the death benefit early, because the payout to beneficiaries is reduced by the amount you withdraw. There are no taxes on partial withdrawals as long as you do not remove more money than you have paid in premiums. If you withdraw more than you paid, you will be taxed on the difference.
• Whole life insurance policies - We normally do not recommend making a partial withdrawal if you have a whole life insurance policy because the insurer will frequently cut your death benefit by a greater amount than you remove. If the policy is too large, you may wish to negotiate a life insurance settlement or simply surrender it.

Increase your death benefit with paid-up additions

If you have a large sum of money but don't know what to do with it, you may be able to raise the amount of money left to your beneficiaries. This option isn't always accessible, so check with your insurer first, but it's a simple method to ensure that your family doesn't simply lose the financial worth you've put up over time.

Similarly, if you have a mutual insurers participating whole life insurance policy, you can utilize any dividends you receive to acquire paid-up additions. Purchasing paid-up additions is akin to purchasing a small single-premium life insurance policy in that you raise the cash value and death benefit but do not have continuous payments.

Finally, there are no medical exams or underwriting criteria when purchasing paid-up extras, allowing you to enhance your coverage even if your health has deteriorated.