Like many things in life, shopping for a life insurance policy is not a simple task. Without a full grasp of insurance terminology, policy types and riders, it's hard to identify a policy that best suits your needs.
The net cash value component of some permanent life insurance policies is one element of a policy that can be confusing. So, think about it this way, cash value life insurance (CVLI) is a form of permanent life insurance that includes a cash value savings component. This component allows a policyholder to use the policy's cash value to pay the policy's premiums, acquire cash or obtain a loan.
Life Insurance Net Cash Value
The monthly premium of a cash value life insurance policy will be higher than that of a term life insurance policy due to its cash value savings component. One portion of the fixed-level premium pays the cost of insuring you and goes toward policy fees and changes, and the second portion is deposited by the insurer in a cash value account in the policyholder's name.
As long as the cash remains in the account, the money earns a rate of interest for which taxes are deferred until the time of its withdrawal. Consequently, the policy's cash value and the policyholder's interest earnings increase tax-free over time.
Also, the cash in the cash value account offsets a portion of the insurer's liability and its risk. In fact, as the cash in the savings account grows, the insurer's risk declines. The following example illustrates how this occurs.
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Cash Value Life Insurance Example
Assume that you purchase a cash value life insurance policy with a $50,000 death benefit. Also, assume that over time, your policy's cash account grows to $10,000. When you die, the insurance company will pay your beneficiary a death benefit of $50,000. The $50,000 includes the $10,000 in your cash account. Consequently, while the insurance company's liability is $50,000, the actual cost of the death benefit to the company is $40,000.
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Access Policy Cash Value
As a cash value life insurance policyholder, you have multiple options for accessing funds. Some policies allow a cash surrender or withdrawal, each of which can reduce the policy's death benefit.
Other policies allow a policyholder to make unlimited withdrawals. Still, others restrict the number of withdrawals a policyholder can take during a term or calendar year or limit the cash amount the policyholder can withdraw.
The CVLI Loan
As a policyholder, you can use the cash value of your policy as a savings account and borrow from it when need be. The maximum amount of your loan is based on your policy's current cash value. As with other loans, the insurance company will charge you interest on your loan's outstanding principal.
During the period of your loan, the policy's death benefit is decreased by the amount of the outstanding loan amount. Some insurers require the repayment of interest on the loan as well as the principal before a beneficiary receives the full value of your policy.
CVLI Premium Payments
As a cash value life insurance policyholder, assuming there's sufficient cash in the account, you can pay your life insurance premiums using the policy's cash value. In fact, depending on your policy's cash value, you might begin to rely on the premiums being paid entirely from your account's cash value, rather than make out-of-pocket payments.
Tax-Deferred Cash Accumulation
The interest you earn on the savings component of your policy is tax-deferred. This means that you don't pay tax on the earned interest until you withdraw it from your account. At that time, you are taxed at your current tax rate.
If you want to purchase a cash value life insurance policy, you have multiple options. While each policy may accrue cash value differently, each one allows you to get to your cash value with a loan or withdrawal.
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