A cash-value life insurance policy, often referred to as permanent life insurance, is a type of life insurance that provides both a death benefit to your beneficiaries and a savings component that accumulates cash value over time. This type of policy typically comes in two main forms: whole life insurance and universal life insurance. Here’s how it works, from an other view:
- Premium Payments: When you purchase a cash-value life insurance policy, you agree to make regular premium payments, typically on a monthly or annual basis. These premiums cover the cost of the insurance protection, and administrative fees, and contribute to the cash value component of the policy.
- Death Benefit: The primary purpose of any life insurance policy is to provide a death benefit. In the event of your death, the insurance company pays a lump sum, a tax-free death benefit to your designated beneficiaries. This money can be used by your beneficiaries for various purposes, such as paying off debts, covering funeral expenses, or providing financial support.
- Cash Value Accumulation: A unique feature of cash-value life insurance is the cash value component. Part of your premium payments go into a cash-value account, which is invested by the insurance company. Over time, this cash value accumulates and grows, typically at a guaranteed minimum rate set by the policy. Some policies also offer the potential for higher returns based on the performance of underlying investments.
- Tax Benefits: The cash value in a life insurance policy grows tax-deferred, meaning you don’t pay income tax on the gains as they accumulate. In addition, if you take out loans or withdrawals from the policy, they are often tax-free up to the amount you’ve paid in premiums. However, there may be tax consequences if you exceed certain limits or surrender the policy.
- Access to Cash Value: You can access the cash value of your policy through policy loans or withdrawals. Keep in mind that taking money out of your policy can reduce both the death benefit and the cash value, and any outstanding loans may reduce the death benefit further.
- Policy Flexibility: Depending on the type of cash-value policy, you may have the flexibility to adjust your premium payments, death benefit, and cash-value investment options over time. Universal life insurance policies, in particular, offer more flexibility in this regard.
- Surrender Value: If you decide to cancel (surrender) the policy, you can receive the cash surrender value, which is the accumulated cash value minus any surrender charges or fees imposed by the insurance company.
- Estate Planning: Cash-value life insurance can be used as an estate planning tool to transfer wealth to heirs or cover estate taxes.
- Dividends: Some whole life insurance policies pay dividends to policyholders based on the insurance company’s financial performance. These dividends can be taken as cash, used to purchase additional insurance coverage, or left to accumulate within the policy.
It’s important to note that cash-value life insurance policies tend to have higher premiums compared to term life insurance, which provides coverage for a specific term (e.g., 10, 20, or 30 years) without a cash value component. Whether a cash-value policy is suitable for you depends on your financial goals, risk tolerance, and insurance needs, so it’s advisable to consult with a financial advisor before making a decision.