Cash life insurance, commonly referred to as cash value life insurance, combines the security of a life insurance policy with an investment feature that can offer an appealing rate of return, depending on your financial goals. What’s more, it also comes with intriguing tax benefits for those looking to keep more of their hard-earned money. But is it too good to be true?
It might surprise you to learn that cash life insurance has been around for hundreds of years and is regularly utilized by both families and businesses as a way to grow and preserve their wealth. When purchased through top-rated mutual insurance companies, it can be one of the most secure financial decisions you make. Keep reading to find out how cash life insurance really works and see if it’s right for you.
HOW CASH LIFE INSURANCE WORKS
Cash life insurance is permanent life insurance that gives you more options and comes with more guarantees than term life insurance.
Most people are familiar with term life insurance. When you pay a term life insurance policy premium, all your money goes toward the death benefit of the policy (minus administrative costs and fees). If you don’t die within the specified term, the policy doesn’t pay out.
Cash life insurance works differently, in that your premium gets split between multiple accounts: your death benefit and the cash value account. Cash value earns interest that can be withdrawn on a tax-deferred basis, or it can be borrowed tax-free, at any point during your lifetime. When you pass away, regardless of when you die, your policy will pay out a death benefit.
How you choose to utilize your cash value is entirely up to you. Common uses include borrowing it to purchase real estate, generate business capital, pay for childrens’ education, fund retirement, or as an emergency fund. It can even be used to pay future insurance policy premiums. And if you decide you no longer want your policy, you can surrender it and take a payout from your insurance company. This payout is generally equivalent to your cash value, minus any early surrender fees (usually charged if you surrender your policy within the first 10 years of ownership).
Some permanent life insurance policies grow wealth faster than others, and each has its own risks. Here’s what you need to know before choosing which type of cash value policy is best for you:
Guaranteed Universal Life Insurance
Guaranteed universal life insurance is one of few types of permanent life insurance that earn little to no cash value. In essence, these policies function more like term life insurance policies but they provide coverage for your entire lifetime. If you’re looking for cash life insurance, do not buy a guaranteed universal life policy.
Universal Life Insurance
Cash value in universal life insurance grows based on a variable rate set by your insurance company. In recent years, universal life policies have fallen out of favor due to diminishing returns. The biggest appeal of a universal life policy is that it offers flexibility with premium payments. You may have the option of reducing your premium if needed, although it may also reduce your death benefit.
Indexed Universal Life Insurance
With similar flexibility to standard universal life policies, indexed universal life grows cash value based on a stock index, like the S&P 500. Your insurer chooses which index to use and you’re exposed to the market risks that come along with investing in stocks, within certain limits. Some insurers place a floor on your investment, meaning if the index performs below a certain level, you’re guaranteed at least a minimum return. However, they may also place a ceiling on your investment, meaning if the index performs well, you may only be entitled to earn a certain percentage of interest.
Variable Life Insurance
Rather than investing cash value in a stock index, variable life policies invest cash value in sub-accounts selected by your insurer. These sub-accounts function similarly to mutual funds; they can offer the highest returns but have the fewest guarantees and are generally best for policyholders willing to take on considerable risk. These types of policies can be set up as universal policies with some flexibility in premium payments, but also tend to have the highest management fees, as you’re paying both your insurance administrative costs as well as the cost of managing mutual funds.
Whole Life Insurance
Whole life insurance doesn’t offer flexible premiums. Whatever rating you purchase your policy at will remain in effect for the duration of your lifetime. If you have steady income, knowing your policy won’t fluctuate can be a great tool when it comes to financially planning your future. In addition to a guaranteed fixed premium, you also earn a guaranteed fixed rate of return on your cash value, set by your insurance company.
Wealth Maximization Account™
A Wealth Maximization Account is a type of whole life insurance policy purchased through one of several top-rated mutual insurance companies. Mutual insurance companies pay out non-guaranteed dividends on top of any guaranteed interest earned, and dividends are usually tax-free. The mutual insurance companies we work with at Paradigm Life have historically paid out dividends for over 100 years.
In addition to dividends, which help exponentially grow wealth inside a life insurance policy, we structure our participating policies with a paid-up additions rider (PUAR) that allows policyholders to “overfund” their policy in its earlier years — putting more money into the cash value account and less toward the death benefit in order to earn more interest faster and maximize growth over time while maintaining tax-advantaged status. Dividends can be used to purchase paid-up additions in early years and then reallocated to pay for insurance premiums in later years.
PROS & CONS OF CASH LIFE INSURANCE
No financial product is one-size-fits-all, and having a clear picture of your financial goals is key to finding the right tools to succeed. While each type of life insurance listed above influences how your policy grows cash value and comes with its own unique benefits and risks, the following pros and cons apply to all cash life insurance policies in general.
- Cash life insurance policies allow you to utilize tax-free policy loans with a low interest rate set by your insurance company. You determine the payback schedule and there are no credit checks or loan qualifications that need to be met in order to access funds. Loans won’t appear on your credit report.
- Depending on the type of policy you buy, you may still earn interest on your entire cash value regardless of outstanding loan amounts, essentially allowing each dollar to work in two ways at once — both as borrowed money and invested money.
- Cash value can be used to pay policy premiums. This is especially beneficial in later years when your income primarily relies on savings, retirement accounts, and Social Security.
- Because cash life insurance is permanent (provided premiums are paid), you don’t have to worry about coverage terminating and needing to requalify for insurance later, which could result in higher premiums or denial of coverage based on future health status.
- Cash life insurance policies offer investment options that can be less risky than market based investments, depending on the type of policy you buy.
- Cash life insurance policies offer more lucrative returns compared to high-interest savings accounts or other types of bank savings.
- Cash life insurance policies offer options for high-income individuals who have maxed out other investment products like qualified retirement plans.
- Cash life insurance purchased with an irrevocable life insurance trust (ILIT) can help lower estate taxes.
- Cash life insurance policies can be customized with riders, including — but not limited to — a paid-up additions rider. Other riders include accelerated death benefit, guaranteed insurability, disability, long-term care, and riders for additional family, like your spouse and children.
- For individuals who have lifelong insurance needs or who have children who will always be dependents, permanent life insurance is a must. Choosing a cash life insurance policy gives you more benefits and flexibility.
- Unpaid policy loans will be deducted from your policy’s death benefit, plus interest, and will reduce the amount left to your beneficiaries. If your goal is to leave money to your heirs, this could be a problem. However, if your goal is to use policy loans to fund retirement, you essentially pay for your retirement with your life insurance policy.
- Cash value does not pass down to your beneficiaries; you must use it during your lifetime.
- If you deplete your cash value or miss a premium payment, you may void your policy and no longer have insurance coverage.
- Cash life insurance is more expensive than term life insurance, especially in the earlier years of the policy.
- Cash life insurance policies that aren’t properly structured can run the risk of becoming modified endowment contracts (MECs) where the ratio of cash value to death benefit voids tax benefits.
- Cash life insurance policies take time to grow wealth and should be used to support long-term goals rather than short-term cash needs, until sufficient cash value has accumulated.
- Cash life insurance policies can be more complicated than term policies and require active involvement on the part of the policyholder.
YOUR PATH TO PERPETUAL WEALTH
Now that you know how each type of cash life insurance works and the pros and cons of owning cash value policies, it’s time to see a customized illustration with your own financial goals in mind.
At Paradigm Life we can customize a policy to fit your financial situation. Our expert Wealth Strategists are available to answer your questions and show you customized illustrations, outlining an individual plan of action to help you achieve your goals. , no strings attached.