When it comes to life insurance, there are many options available to consumers. One type of policy that has gained popularity in recent years is cash-value life insurance. This is mainly because, unlike traditional term life insurance, cash-value policies offer both protection for your loved ones and a savings component that can accumulate over time. However, like any financial product, cash value life insurance has both advantages and disadvantages that should be carefully considered before making a decision.

In this article, we will examine the top 14 advantages and disadvantages of cash value life insurance to help you determine if this type of policy is right for you.

Table of Contents:

• How Does Cash Value Work?
• Cash Value Benefits and Drawbacks
• Does All Life Insurance Have Cash Value?
• Can I Cash Out My Life Insurance?
• How Long Does It Take To Get My Cash Value?
• What Happens When You Borrow Money From Life Insurance?
• How Soon Can I Borrow From My Policy?
• Do You Have To Pay Back Loans?
• How Much Can I Borrow?
• Can I Cash Out Before Death?
• What Happens To The Cash Value When I Die?
• Cash Value Vs Surrender Value: What is the Difference?
• Is Cash Value Taxable?
• Why is Cash Value Life Insurance Bad?

How does the cash value of life insurance work?

Cash value life insurance is a type of permanent life insurance that offers both a death benefit and a savings component. A portion of the premiums paid towards the policy are set aside and invested, allowing the policyholder to accumulate cash value over time. This cash value can be used in a variety of ways, such as borrowing against it, withdrawing it, or using it to pay future premiums.

How is Cash Value Calculated?

The amount of cash value that a policyholder can accumulate depends on several factors. These include the initial premium, the death benefit amount, the policy’s length, the type of investment vehicle chosen by the insurer, and the policyholder’s age, gender, and health. Typically, the younger and healthier the policyholder is at the time of purchase, the greater the potential for cash value growth.

Types of Cash Value Investments

The insurer will typically invest the cash value portion of the policy in various assets, such as bonds, stocks, or mutual funds. The policyholder may have the option to choose from a selection of investment vehicles offered by the insurer or customize their investments according to their risk tolerance and financial goals. The returns on these investments can vary based on market performance and other factors, which can impact the overall growth of the cash value.

Using Cash Value

One of the advantages of cash value life insurance is that the policyholder can use the cash value for a variety of purposes. For example, they may be able to take out a loan against the cash value, with the policy itself serving as collateral. They may also be able to withdraw a portion of the cash value, although this may result in a reduction in the death benefit. Alternatively, they may be able to use the cash value to pay future premiums, effectively reducing or eliminating the need for additional out-of-pocket expenses.

What are the benefits and drawbacks of cash-value life insurance?

Cash value life insurance can be a valuable financial tool for some individuals, but it is not the right option for everyone. Here are some of the benefits and drawbacks to consider before choosing a cash-value life insurance policy:

Benefits of Cash Value Life Insurance:

1. Lifetime coverage: Cash value life insurance is a permanent policy, meaning it provides coverage for the policyholder’s entire life, as long as premiums are paid.
2. Tax-deferred growth: The cash value portion of the policy grows tax-free, meaning policyholders do not have to pay taxes on the earnings until they withdraw the funds.
3. Access to cash: Policyholders can access the cash value portion of the policy in a variety of ways, such as through loans or withdrawals, which can provide financial flexibility and liquidity.
4. Potential for growth: The cash value portion of the policy can grow over time, potentially providing an additional source of retirement income or a means of leaving an inheritance for loved ones.
5. Protection from market downturns: Unlike some other types of investments, the cash value of a life insurance policy is generally protected from market downturns.

Drawbacks of Cash Value Life Insurance:

1. Higher premiums: Cash value life insurance typically has higher premiums than term life insurance, which can make it a more expensive option for some individuals.
2. Limited investment options: The investment options for the cash value portion of the policy may be limited, and the returns on those investments may not be as high as other investment vehicles.
3. Complexity: Cash-value life insurance policies can be complex, so it’s important for policyholders to fully understand the terms and conditions of their policy.
4. Long-term commitment: Cash value life insurance policies are meant to be held for the long term, and canceling the policy early can result in significant penalties and surrender charges.
5. Lower rate of return: While the cash value portion of the policy can provide a source of savings and investment, the rate of return may not be as high as other investment options.

It’s important for individuals considering cash-value life insurance to carefully evaluate their financial goals and needs, as well as the specific terms and conditions of the policy, before making a decision.

Does all life insurance have cash value?

Different types of life insurance policies are available, with some offering a cash value component while others do not.  For example…

Term Life Insurance: Term life insurance is the most common type of life insurance policy. It provides coverage for a specific term or period, typically one to thirty years. Term life insurance policies do not have a cash value component as they are designed to provide a death benefit to the beneficiaries in the event of the policyholder’s death during the term. Once the term ends, the policy will expire, and there will be no cash value accumulated.

Permanent Life Insurance: Permanent life insurance, on the other hand, offers a cash value component that accumulates over time as the policyholder pays premiums. There are different types of permanent life insurance policies, such as whole life insurance, universal life insurance, and variable life insurance. The cash value component of these policies allows policyholders to borrow against it, withdraw it, or use it to pay future premiums.

• Whole Life Insurance: Whole life insurance is a type of permanent life insurance that provides coverage for the policyholder’s entire life, as long as premiums are paid. A portion of the premium paid goes towards the cost of insurance, while the remaining portion goes towards building cash value. The cash value component of whole life insurance grows at a fixed rate and is tax-deferred.
• Universal Life Insurance: Universal life insurance is another type of permanent life insurance that offers more flexibility than whole life insurance. The policyholder can adjust the premium and death benefit amount and the timing and amount of premium payments. The cash value component of universal life insurance grows at a variable rate and is also tax-deferred.
• Variable Life Insurance: Variable life insurance is a type of permanent life insurance that allows policyholders to invest the cash value component in various investment options, such as stocks, bonds, and mutual funds. The growth of the cash value component depends on the performance of the investments. Variable life insurance policies are more volatile than other types of permanent life insurance due to the risks associated with investing in the stock market.

So as you can see, not all life insurance policies have a cash value component. Term life insurance policies do not have a cash value component, while permanent life insurance policies, such as whole life, universal life, and variable life, offer a cash value component that accumulates over time.

Can I cash out my life insurance?

Yes, it’s possible to cash out a life insurance policy, but the specific terms and conditions depend on the type of policy and the insurance company. If you have a term life insurance policy, there is no cash value component, so you cannot cash it out. However, if you have a permanent life insurance policy, such as Whole Life or Universal Life, you may have the option to surrender the policy and receive the cash value.

Surrendering a life insurance policy: means that you are canceling the policy and forfeiting the death benefit in exchange for the cash value. The cash value is the amount of money that has accumulated in the policy over time, including the premiums paid and any interest earned. However, surrendering the policy may result in tax consequences and fees, which could reduce the amount of cash received.

If you don’t want to surrender the policy entirely, you may also have the option to take out a policy loan against the cash value. A policy loan allows you to borrow money from the policy’s cash value while keeping the policy in force. The loan will need to be paid back with interest, and if you don’t pay it back, the outstanding balance will be deducted from the death benefit paid to your beneficiaries.

In summary, it is possible to cash out a life insurance policy with a cash value component, but the specific terms and conditions depend on the type of policy and the insurance company. Suppose you are considering cashing out your policy or taking out a policy loan. In that case, it’s essential to understand the potential tax consequences and fees to ensure that it’s the right decision for your financial situation.

How long does it take to get cash value from life insurance?

The time it takes to build up cash value in a life insurance policy can vary depending on the type of policy and the insurance company. In general, permanent life insurance policies, such as whole life or universal life, build up cash value over time as the policyholder pays premiums. The cash value component usually takes several years of consistent premium payments to accumulate.

Fortunately, the cash value in a life insurance policy grows tax-deferred, which means that policyholders do not pay taxes on the growth until they withdraw or borrow against the cash value. However, the cash value may be subject to surrender fees or other charges, which could reduce the amount of cash value available.

If you decide to surrender the policy and receive the cash value, the insurance company may take several weeks to process the request and issue the payment. The exact timeframe for receiving the cash value will depend on the company’s policies and procedures, and it should be something that you ask about and consider before choosing an insurance carrier to apply with.

We should note that if you decide to take out a policy loan against the cash value, the process may be faster since the insurance company is essentially lending you your own money. However, you will need to pay back the loan with interest, and if you don’t repay the loan, the outstanding balance will be deducted from the death benefit paid to your beneficiaries.

So in summary, it generally takes several years of consistent premium payments for the cash value component in a life insurance policy to accumulate. The timeframe for receiving the cash value will depend on the insurance company’s policies and procedures, and if you take out a policy loan, you will need to repay the loan with interest.

What happens when you borrow money from your life insurance policy?

When you borrow money from your life insurance policy, you are essentially borrowing from the policy’s cash value. The cash value is the amount of money that has accumulated in the policy over time, including the premiums paid and any interest earned.

Here’s what happens when you borrow money from your life insurance policy:

1. You request a policy loan: If your policy has accumulated sufficient cash value, you can request a policy loan from your insurance company. The loan amount is usually limited to a percentage of the cash value, and you will need to pay interest on the loan.
2. You receive the loan amount: Once your request is approved, the insurance company will issue you the loan amount in the form of a check or direct deposit.
3. You repay the loan: You will need to repay the loan with interest to the insurance company. The interest rate is typically lower than what you would pay on a credit card or personal loan, and the loan can usually be repaid over several years.
4. You maintain the policy: The policy will remain in force as long as you continue to pay your premiums and interest on the loan. If you don’t repay the loan, the outstanding balance will be deducted from the death benefit paid to your beneficiaries.
5. You may owe taxes: Policy loans are generally not considered taxable income. However, any outstanding loans may be subject to taxes and penalties if you surrender or lapse the policy.

It’s important to note that borrowing from your life insurance policy can reduce the amount of cash value and death benefit available to you and your beneficiaries. It’s also important to carefully consider the terms and conditions of the policy loan and ensure that you have a plan to repay the loan with interest.

How soon can I borrow money from my life insurance policy?

The timing for when you can borrow money from your life insurance policy will depend on the type of policy you have and the insurance company’s policies. In general, you can only borrow money from the cash value of a permanent life insurance policy, such as whole life or universal life insurance ( as mentioned before, Term life insurance policies do not have a cash value component and cannot be borrowed against).

Now once you have a permanent life insurance policy with a cash value component, it usually takes several years of consistent premium payments for the cash value to accumulate to a point where you can borrow from it. The exact timeframe for when you can borrow money from the policy will depend on the insurance company and the policy’s specific terms and conditions.

Some insurance companies…

May allow you to take out a policy loan as soon as the cash value has accumulated to a certain threshold, while others may require a waiting period of several years. Additionally, some policies may have surrender charges or other fees that could impact the amount of cash value available to borrow against.

If you need to access funds sooner than the cash value accumulation period allows, you may consider alternative options such as a personal loan or line of credit. However, keep in mind that these options may come with higher interest rates and fees compared to a policy loan.

Do you have to pay back loans on life insurance?

Yes, you do have to pay back loans on life insurance policies. When you borrow money from your life insurance policy, you are essentially borrowing from its cash value, which is the amount of money that has accumulated in the policy over time, including the premiums paid and any interest earned.

Policy loans typically come with an interest rate that you will need to pay back to the insurance company in addition to the loan principal. The interest rate is usually lower than what you would pay on a credit card or personal loan, and the loan can usually be repaid over a period of several years.

Now, if you don’t pay back the loan…

The outstanding balance will be deducted from the death benefit paid to your beneficiaries when you pass away. This means that your beneficiaries may receive less money than they would have otherwise received. In some cases, policy loans may also impact the cash value and death benefit of the policy, so it’s important to understand the terms and conditions of the policy loan and ensure that you have a plan to repay the loan with interest.

It’s also important to note that policy loans are not considered taxable income. However, as we mentioned before, if you surrender or lapse the policy, any outstanding loans may be subject to taxes and penalties.

How much can I borrow from my life insurance?

The amount you can borrow from your life insurance policy will depend on the type of policy you have and the amount of cash value that has accumulated in the policy. Cash value is the portion of your premium payments that accumulate in the policy and can be used for loans or other purposes.

In general, the maximum amount you can borrow is equal to the policy’s available cash value. However, some insurance companies may also have a minimum and maximum loan amount, so it’s important to review the policy terms and conditions to determine the specific loan limits.

Can you cash out life insurance before death?

Yes, it is possible to cash out a whole life insurance policy before the insured person’s death. This is known as a “policy surrender.” When a policyholder surrenders their whole life insurance policy, they receive the policy’s cash surrender value, which is the amount of money the policy has accumulated over time.

However, surrendering a whole life insurance policy may have tax implications, and the amount received may be less than the total premiums paid into the policy. It is important to consider the financial implications before surrendering a whole life insurance policy.

It may also be possible for term life insurance policy owners to also “cash out,” except in this situation, the policyholder will sell their life insurance policy to a third party for a lump sum payment.  This process is commonly referred to as a “life insurance settlement” or “life settlement.”  We should not, however, that the amount received for selling your term life insurance policy will likely be significantly less than the death benefit of the policy, and the decision to sell a life insurance policy should be carefully considered as it can have tax and other financial implications.

What happens to the cash value when you die?

When the owner of a whole life insurance policy dies, the policy’s cash value is typically paid out to the policy’s beneficiaries tax-free along with the policy’s death benefit. However, any outstanding loans or unpaid premiums may be deducted from the cash value before they are paid out to the beneficiaries. It’s important to note that the death benefit paid out to the beneficiaries will be reduced by any amount of outstanding loans or unpaid premiums as well.

Additionally, if the policyowner had named their estate as the beneficiary, the cash value and death benefit may be subject to probate and other legal processes.

What is the difference between cash value and surrender value of life insurance?

A life insurance policy’s cash value and surrender value are closely related, but they are not exactly the same thing.

The cash value of a life insurance policy is the amount of money that has accumulated within the policy over time. This value is based on the premiums paid into the policy, the interest earned on those premiums, and any fees or charges associated with the policy. The cash value is also considered an asset of the policyholder, and it can be accessed through policy loans or withdrawals.

The surrender value of a life insurance policy is the amount of money that the policyholder would receive if they were to surrender or cancel their policy. The surrender value is typically equal to the policy’s cash value minus any surrender charges or fees that may apply. Surrendering a policy means the policyholder forfeits the death benefit protection, and the policy is no longer in force.

So, while a life insurance policy’s cash value and surrender value are related, the cash value represents the amount of money available within the policy. In contrast, the surrender value represents the amount of money available if the policy is surrendered or canceled.

Is the cash value of life insurance taxable?

The tax treatment of a life insurance policy’s cash value depends on how it is accessed or withdrawn. Now, if the policyholder accesses the cash value through a policy loan or withdrawal, the amount of the cash value they receive is generally not taxable, up to the amount of premiums paid into the policy. This is because the cash value represents a return of the policyholder’s own money, rather than a taxable gain.

However, suppose the policyholder surrenders the policy and receives the cash surrender value. In that case, the amount of the surrender value that exceeds the total premiums paid into the policy is generally taxable as income. In addition, any gains on the policy, such as interest or investment returns, are also generally taxable as income.

It’s important to note that the tax rules around life insurance policies can be complex, and exceptions or special circumstances may apply in certain cases. It’s always a good idea to consult with a tax professional or financial advisor to fully understand the tax implications of accessing the cash value of a life insurance policy.

Why is cash-value life insurance bad?

Through most of the Twentieth Century, buying cash-value life insurance (especially whole life) was considered a wise financial decision for most people. During your working years, your family is protected by the death benefit. Then, when you reach retirement age, you can either tap the cash value as an asset to fund retirement or keep the policy in place as an inheritance for your heirs.

More recently, celebrity consumer-finance pundits like Suze Orman and Dave Ramsey have recommended against whole life. In a nutshell, they say you are better off if you “buy term and invest the difference.” They want you to purchase term coverage to meet your life insurance needs and use the money you save with the cheaper premiums to invest for retirement.

The idea is that…

If you invest the money in the stock market, you’ll see better returns than what you would get from your whole life. In our opinion, this critique is not illegitimate, but it relies on a few unstated assumptions.

First, it assumes that you will reach a point where you no longer need life insurance. By definition, term coverage eventually ends, which is a big part of why it’s cheaper—the vast majority of term policies never pay out. But many people need to be certain that life insurance proceeds will be available, and term doesn’t provide that certainty. If you need to provide for the long-term care of a disabled loved one, apply the money toward funeral costs, or guarantee estate liquidity, you’ll need permanent life insurance.

Second, “buy term and invest the difference” assumes that you will, in fact, invest the difference and see growth equal to historic stock market returns. However, there is a distinct possibility of choosing the wrong investments or that the market will crash or stagnate. Of course, the strategy will fail if you use the money for other things or forget to invest it.

Whole life offers fixed, guaranteed returns and no risk of loss.

Universal life is designed to allow for more growth in strong markets, but without significant risk of loss.  Neither product is intended as a high-risk/high-reward investment.

They are secure, stable, reliable assets that can provide a hedge against market volatility.

For some people, “buy term and invest the difference” is a good strategy.  For others, cash-value life insurance is the smarter play.

Conclusion

After reading this article, we don’t expect you to be an expert in cash value life insurance, but we hope we provided you with some good information to chew on. The bottom line is, whether you are in the market for term life or cash value life insurance, we can help you find the best policy for you based on your specific needs and goals.

We work with dozens of the top life insurance companies. Our goal is to align you with the company and policy that best meets your criteria. So what are you waiting for? Give us a call today and experience the IBUSA difference.