What is the Cash Value of Whole Life Insurance?
The cash value of whole life insurance is the contractual dollar amount the insurance company will exchange with a policy owner in the event the insurance policy is cancelled. This same cash value is the basis by which the insurance company will loan to the policy owner. The loan is collateralized by the cash value. The insurance company will not lend the policy owner more than the total cash value of the policy owner’s life insurance policy. The cash value of whole life insurance is also accessible by the policy owner through a partial surrender, which is a physical withdrawal of the cash value.
To better understand the cash value of whole life insurance, it is important to understand what cash value is, how it grows, and how it can be utilized.
Cash Value Growth
Whole life insurance is a unilateral contract between the insurance company and the policy owner. In this contract there are guarantees and benefits to the policy holder(s), one of which is guaranteed cash value growth. Cash value grows tax free. When the cash value is withdrawn for income or otherwise, it is also tax free until the withdrawals exceed the basis of the policy. The basis is the amount of premiums that have been paid over time by the policy owner. At this point the withdrawals are taxed at ordinary income tax rates.
The cash value of whole life insurance also grows if the policy owner elects to have his dividends buy a paid-up additions rider. Dividends are declared every year by the mutual insurance company who issued the policy. In the subsequent year, they are divided amongst policy owners on the anniversary date of their policy. The anniversary date is the month and day the policy was originated. Although dividends are not guaranteed, mutual insurance companies have a long track record of paying dividends. Some companies have paid for over 100 years.
Loans Against Cash Value
Through the policy loan provision, a policy holder can access the value of his cash value without incurring taxes. This is because policy loans are treated as debt, which is not a taxable distribution. A similar financial transaction is a real estate cash out refinance. No taxes are paid on the refinance proceeds. Although policy loans are not required to be paid back, it is recommended. The insurance company charges interest on the outstanding policy loan but does not require payments to be made. However, an outstanding policy loan will reduce the overall available cash value and if death were to occur with an outstanding policy loan, the loan would be paid back via the death benefit proceeds.
Whole life insurance is a unique financial product because of the guarantees, tax benefits, and historical positive performance. For more information on the cash value of whole life insurance and how it can play a part in your financial situation, schedule a free consultation with a Paradigm Life Wealth Strategist. We’re here to answer all your questions, no strings attached.
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