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Cash value life insurance: What's it worth to you?

Life insurance can give your family an additional financial safety net. There are big differences between term life insurance and the multiple types of permanent life products like whole life and universal life. Cash value is one of them. 

Whole life and universal life policies offer this benefit. Term life policies don't. However, the trade-off is that you'll pay a higher premium to get cash value life insurance.

Getting this type of life insurance makes sense for some consumers. Here's what you need to know about cash value life insurance and whether this type of insurance protection is right for you.

 

What is whole life cash value life insurance?

Whole life insurance provides a death benefit that is paid to your beneficiaries when you die. It also provides cash value that you can tap into after having the policy for several years.

A whole life’s cash value differs from a universal life policy in terms of how the interest is credited to the policy.

"Whole life credits interest based on dividends declared by the insurance company. If the insurance company declares a 5% dividend for the year, then your policy is credited with 5%," says Chris Abrams, a licensed insurance agent and owner of Abrams Insurance Solutions.

With an indexed universal life policy, the insurance company credits interest based on the performance of a stock market index, typically the S&P 500. Abrams says at the end of the year, a policyholder receives the same return as the index. However, if the index has a negative return for the year, your policy won’t get any return at all. Your policy also may have a cap, even if the index overperforms.

"For instance, if the S&P index cap is 12% and the S&P returns 14% for the year, then your policy is credited with 12%," Abrams says.

The advantage of an indexed universal life policy is that you can get a better return over time if the index performs well. However, that comes with more risk. That’s not the case with a whole life insurance policy. Whole life policy guarantees returns.

 

How does cash value life insurance work?

When you get a whole life or universal life policy, you pay a premium on either a monthly or annual basis. 

The way the premiums are set vary: 

  • Whole life insurance policies have fixed premiums.
  • Premiums for indexed universal life policies are more flexible. 

    In an indexed universal life policy, you can pay a lower premium or skip premiums altogether if there's enough cash value in the policy, says Sam Price, an independent agent & Broker with Assurance Financial Solutions.

    Your insurance company will apply part of your premium payments to your policy to fund the death benefit and invest the other portion in the market. The latter part is what builds up cash value. 

    You get the most benefit from cash value while you're alive. You can use it in several ways: supplement your retirement income, pay down debt or cover certain expenses. 

    Here are three ways you can use cash value:

    • Pay your premiums: Most insurers will only allow you to do this after you've owned the policy for at least a year. If you go with a universal life policy, you could end up depleting all the cash value built up in the policy.
    • Take out a loan against your policy: You can draw down some of your cash value in the form of a loan, which you'll have to pay back with interest. The downside to this approach is that if you don't pay back the loan, the amount will be deducted from the death benefit your beneficiaries receive.
    • Partially or fully withdraw money from your policy: You can withdraw money outright from cash value life insurance. Doing this in a whole life insurance policy could reduce the death benefit by more than the amount you withdraw. In a universal life policy, it may reduce the death benefit on a dollar-for-dollar basis. For example, if you have a $250,000 policy and withdraw $25,000, your beneficiaries will only receive a $225,000 death benefit from your policy.

      Another important thing to remember about cash value life insurance is that you can't surrender the policy in the initial years or you'll lose value.

      "You can have $10,000 of cash value, but that doesn't mean that's the amount you'll walk away with if you were to surrender or cancel that policy. The surrender value in the first few years of the policy is going to be less than the cash value," Price says.

      Before deciding on how to use your policy’s cash value component, it's crucial to run the numbers. Below is an example from New York Life Insurance Co. of the effect of using the cash value to pay premiums vs. paying them out of pocket. Remember, these numbers can vary depending on the insurer, the policy type, the policy amount and your rating or risk classification (preferred plus, preferred, standard, etc.).

      The following charts illustrate how much cash value a 35-year-old nonsmoking male with a preferred-rate $100,000 whole life insurance policy could build up over his lifetime. Policy values and benefits shown are based on a dividend scale that is not guaranteed and could be more or less than what's shown.

      Example 1: Using cash value to offset premium payments

      Year of policyAgePremium paid out of pocketCash surrender valueDeath benefit
      540$1,178$3,738$100,370
      1045$1,178$11,569$101,513
      17*52$0$24,301$105,410
      20*55$0$28,363$102,240
      30*65$0$46,379$100,609
      35*70$0$58,528$104,122
      48*83**$0$102,717$129,423
      50*85$0$110,982$135,021
      55*90$0$133,638$151,824

      * For these years the premium payment is assumed to be completely or partially paid through the use of dividend values. A change in dividends could result in the resumption of premium payments.
      ** This year represents the insured's life expectancy.

      Example 2: Paying all premiums out of pocket

      Year of policyAgePremium paid out of pocketCash surrender valueDeath benefit
      540$1,178$3,738$100,370
      1045$1,178$11,569$101,513
      1752$1,178$25,551$108,520
      2055$1,178$33,838$114,625
      3065$1,178$72,398$144,881
      3570$1,178$99,839$166,343
      4883**$1,178$206,754$253,326
      5085$1,178$228,317$271,184
      5590$1,178$289,301$323,334

      ** This year represents the insured's life expectancy. Source: New York Life Insurance Co.

      When is cash value life insurance a good idea?

      Cash value life insurance can be a wise investment if you can afford the higher premiums.

      However, one school of thought argues that it's better to "buy term and invest the rest." This avenue means you'd take advantage of the lower premium term life insurance offers for a set period of coverage (typically up to 30 years). You’d then invest the cost savings in the stock market.

      The comparison chart below uses a New York Life Insurance Co. policy to demonstrate the potential financial returns you could reap if you took this approach. This comparison comes courtesy of James Hunt, a retired actuary with the Consumer Federation of America (CFA) and former insurance commissioner of Vermont. His analysis estimates the "real" interest rate earned on savings within a cash value policy.

      (Note: New York Life Insurance Co. is an outlier in illustrating rates of return higher than virtually all other whole life insurance companies. However, whole life insurance generally has returns 1% to 2% lower over 20 years. Universal life policies would have rates of return around 3% lower than New York Life Insurance Co. over 20 years, Hunt says).

      Cash value policy vs. buying term and investing the difference every year

      Year of policyWhole life: PremiumWhole life: Cash surrender valueWhole life: Annual rate of returnTerm life: PremiumInvested difference: Side fund at year end at 4.6%
      1$1,178$0-100.0%$137$1,089
      2$1,178$27-97.4%$138$2,226
      3$1,178$857-19.3%$139$3,414
      4$1,178$2,29321.3%$141$4,655
      5$1,178$3,73812.4%$143$5,950
      6$1,178$5,1948.9%$144$7,303
      7$1,178$6,7678.8%$147$8,715
      8$1,178$8,2525.9%$148$10,190
      9$1,178$9,8536.2%$151$11,729
      10$1,178$11,5696.4%$152$13,337
      11$1,178$13,1554.5%$154$15,017
      12$1,178$14,8234.6%$161$16,766
      13$1,178$16,7055.5%$168$18,587
      14$1,178$18,7135.7%$176$20,484
      15$1,178$20,8185.7%$185$22,457
      16$1,178$23,1276.1%$194$24,511
      17$0$24,3016.0%$205$24,417
      18$0$25,5276.0%$208$26,359
      19$0$26,9116.3%$212$27,341
      20$0$28,3636.3%$217$28,363

      Source: James Hunt, Consumer Federation of America
      Due to space limitations, the full 12-column analysis cannot be displayed.

       

      Pros and cons of cash value life insurance

      Cash value life insurance comes with several advantages:

      • Guaranteed death benefit. 
      • Tax-deferred growth on the invested portion of the policy. 
      • Tax-free benefits to beneficiaries (depending on the size of your estate). 
      • Tax-free loans taken out against the policy.

        Cash value life insurance offers liquidity since you're "able to access your policy without a penalty and taxes before age 59.5 -- unlike a 401(k), IRA or Roth," Abrams says.

        There are cons, though:

        • You must qualify for a policy, which usually requires a health exam.
        • Premiums are much higher for permanent life insurance policies, such as whole life, than they are for term life. That’s mostly because whole and universal life insurance are meant to be long-term savings vehicles.

          If you're weighing your life insurance options, consider whether you can afford the substantial premiums that come with whole or universal life insurance. However, cash value life insurance may be worth considering if you've saved enough for retirement, want to invest with less risk than the stock market and save more than a 401(k) or IRA limits.

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          Comments
          1 Responses to "Cash value life insurance: What's it worth to you?"
          1. Geoffrey Sadler

            Visitors here -- has anyone had any experience with actual companies that purchase life insurance from seniors?

              Reply»  

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