Cash value is an indispensable part of permanent life insurance. In this article, we’ll walk you through everything about it.
Definition of cash value
Cash value is a component of any permanent life insurance policy. When you pay for your life insurance, part of your premium will be divided into three parts. One goes to the service fees, another part accumulates into your death benefit, and the left money is the cash value.
As the year passes, the money will accumulate into a sum that you can use under several conditions. Cash value is tax-free.
How to calculate your cash value?
Many people consider cash value the add-on benefit of permanent life insurance since it is your own money. However, depending on the type of policy that you purchase, your cash value will grow differently. Here is a table for you to compare:
How long does it take you to use your cash value?
It might take at least ten years to build up your cash value. This might be even longer, up to 20 years, depending on your policy. The cash value cannot give you short-term gain, so you need to make sure that you don’t need the money immediately and have other alternatives.
Five ways that policyholders can use their cash value – Pros and cons analysis
Borrowing from your cash value
Pros: As your cash value grows, you have the option to take a loan out of it. The loan is tax-free. In most cases, the interest rate from your cash value will be lower than that in the bank. Another perk is that since the cash is yours, there is no need for any underwriting.
Cons: If you fail to pay back the loan, the insurer will subtract money from your death benefit to compensate for the loss. This means that your death benefit will decrease, and there is less guarantee for your family. In addition, if you decide to lapse on your policy, the remaining loan will be taxed, depending on your premium plus the loan.
Using cash value to pay for your premiums
Pros: It bears repeating that cash value is your own money. So, when it reaches a sizable amount, the insurer will allow you to use it to pay for your premium.
There might come the point when the cash pays most of the premium itself, so you’re relieved from paying the fee. This comes in handy, especially when you are in a financial crisis and can’t pay your premium immediately.
Cons: There is a threshold that you can take your money. This means that you need to make sure that a minimum amount of cash is still there. Otherwise, it will affect your death benefit as well.
Taking a partial withdrawal
Pros: If you’re worried about paying the interest, you still have the option to withdraw part of the money from your cash value. This is called a partial withdrawal. It shares the same principle as taking money out of your bank and using it of your own accord. The good news is the withdrawal is tax-free, so long as your withdrawal doesn’t exceed your paid premium.
Cons: If the withdrawal exceeds your cash amount, additional money is taken from your death benefit. In case you can’t pay back the loss, your death benefit will be reduced. Therefore, you may consult your insurance company about their specific rules and calculate carefully before making your decision.
Making a full surrender
Pros: There may come a time when you want to lapse on your policy. Maybe you can no longer afford your premium, or you are in dire need of money. In these cases, you can decide to surrender your policy and take out a lump sum.
Cons: This is the last resort for everyone since you will lose your beneficiaries’ safety net.
You have to pay a service fee called a surrender fee. If you decide to give up your policy within the first years, there will be no cash reimbursement (since, at this time, the money hasn’t grown much to be counted). However, as you surrender your policy within the first ten years, the insurer will deduct the fee from your cash value.
Selling your policy
Pros: This is another alternative to surrender your policy. When the policy is no longer necessary for you, you may opt to sell it for cash. This transaction is called a life settlement. You will receive a payout that is generally bigger than the cash surrender value. Your buyer will pay for the premium and receive the death benefit when you pass away.
Cons: There are several conditions involved with the transaction. First, you need to be over 65 years old or have a severe medical condition. Second, your policy’s face value must exceed a certain amount (typically at least $200,000).
To sell your policy, you have to work with a life settlement company. The process might take around 3-4 months, so you can’t have your money immediately.
Is cash value an ideal investment?
Not really. The money takes time to accumulate, and it could be much more profitable if you know to invest it in other ways, such as in real estate or the stock market. Instead, it is an add-on benefit of life insurance that acts as a safety net for you and your beneficiaries.
Ensure that you have weighed up the pros and cons that we have mentioned before buying a policy.
Frequently Asked Questions
Does all permanent life insurance have cash value?
All permanent life insurance offers cash value. However, some guaranteed universal life insurance policies do not entail cash value.
What happens to the cash value when I die?
When you die, any cash value that is left in your policy will belong to the insurer. In other words, your beneficiaries do not receive any cash value upon your death. So as not to waste the cash value, you can either take a loan from it, use it to pay the premium or make a partial withdrawal, etc.
Suppose you still prefer a permanent life insurance policy but are not that interested in a cash value. In that case, you may purchase guaranteed universal life insurance, which does not accrue or have little cash value.
What is the difference between cash value and surrender value?
To be precise, the cash value is a part of your premiums that belong to you. You can use it for multiple purposes, for example, making a loan or paying your premium when your policy is still in force. When you decide to surrender your policy, the insurer will give you back your cash value, and this money is also known as surrender value.
One thing to note is that if you decide to surrender your policy too early, you will have to pay a surrender fee. This means that the amount of surrender value you receive is the cash value after deducting the surrender fee. As time passes, when your policy has been in force for long enough, the surrender fee phrases out. At this time, cash value and surrender value refer to the same amount of money you will receive when you surrender your policy.
What does “cash-out” mean?
This phrase means that you can surrender your policy for cash when you no longer need lifelong coverage or want to receive your policy’s benefit now rather than the later death benefit. When you receive the payment, your policy ends, and your death benefit will not be paid in the future.
To do this, you must hand in a form to your surrender to inform them that you will surrender your policy. After deducting the necessary fees, the company will calculate the cash value you will receive and send you the results later.
Is there any tax included when I cash out my policy?
Cash value is tax-free. The money that you withdraw from your cash value is only taxable if it exceeds the total amount of premiums thus far in your policy.
To illustrate, look at the example of Alex – one of our recent clients.
Alex decided to surrender his policy for $15,000, and the amount of his paid premiums thus far was $10,000. This means that he wanted to withdraw $5000 more than what he had paid for his premiums. So, $5000 was taxable.