What Is Cash Value Life Insurance?
Let me explain cash value life insurance to you directly: it's a type of permanent life insurance that covers you for your entire life and includes a savings component where your cash value builds up over time. You can borrow against this cash value, withdraw from it, or even use it to cover your policy premiums.
Key Takeaways
- Permanent policies like whole life and universal life build cash value over time.
- This insurance costs more than term life insurance.
- Unlike term policies, cash value insurance doesn't expire after a set period.
- You can take loans against the policy.
- Withdrawals from the cash value will lower the death benefit.
How Cash Value Life Insurance Works
Cash value insurance provides permanent coverage for your whole life. You'll pay higher premiums than with term life because part of each payment goes toward the insurance cost, and the rest builds your cash value account. This cash value earns interest, and the growth is tax-deferred. As it accumulates, the insurer's risk decreases since the cash value offsets some of their liability.
Example of Cash Value Life Insurance
Take a policy with a $25,000 death benefit, no loans or prior withdrawals, and $5,000 in accumulated cash value. If you die, the insurer pays the full $25,000 death benefit, but they keep the $5,000 cash value, so their actual cost is $20,000. Remember, whole life, variable life, and universal life are cash value types, while term insurance isn't.
Accessing the Cash Value of Life Insurance
The cash value acts as a living benefit you can tap into. You have options like withdrawals, which reduce the death benefit and might be limited by the policy—plus, withdrawing more than your paid premiums gets taxed as income. You can also take policy loans, where interest is charged, and any unpaid amount cuts the death benefit. Or, use the cash value to pay premiums if it's sufficient, letting you skip out-of-pocket payments.
Why Consider Cash Value Life Insurance?
If you're building long-term savings, this could fit alongside an IRA or 401(k), as you can borrow from the cash value built from premiums and interest. Just know cash value might not start growing for two to five years, and early access could mean penalties. Premiums are higher because they fund the savings part. Withdrawals decrease the death benefit, and pulling everything ends the policy—though withdrawals up to your premiums are tax-free, with gains taxed afterward.
The Bottom Line
In summary, cash value life insurance lets you save money tax-free within the policy for future needs. Part of your premium goes into this interest-bearing account, growing over time, and you can access it during your life for various purposes.
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