Are you wondering how cash value life insurance works?
…maybe you are unsure which life insurance even has cash value! If so, you’re one of many.
Cash accumulation is a topic that comes up a LOT in my business.
In fact, I would say most of the people who think they want a whole life policy site the cash value component as the main reason.
…and I can’t blame them.
To be honest who doesn’t want to build up value as they pay their premiums? Unfortunately, there’s more to this than meets the eye.
Using life insurance as an investment vehicle isn’t something I recommend…
…because there are better places to park your hard earned cash.
So if you want to find out which life insurance has cash value and if this is the right move for you and your family read on!
Cash Value Life Insurance - Why You Need an Independent Agent!
If you’re looking for more information about cash value life insurance you need to speak to an independent life insurance agent NOW. I can’t emphasize how important this is.
I think a lot of people are unaware that there is a HUGE difference between a tied agent and an independent agent.
So let’s say you hear that a specific life insurance company is the bomb. Your heart is set on getting a policy from this company and you call them up directly.
The agent on the phone is tied to the insurer in question.
Which means the person on the phone ONLY sells policies for that company! So whether or not they have the best product for you – they’ll peddle what they have.
Chances are if you express interest in cash value they’ll sell you a costly policy you may not need at a price that could be better.
Hey, the commissions on these babies are pretty sweet so there’s a strong incentive.
This is Where Policy Architects Comes In...
So let’s say you decide to call Policy Architects instead. We’re independent which means we have access to the top life insurance companies in Canada.
Our agents perform a personalized assessment to find out where you stand financially. We also fill you in on which life insurance has cash value (hint: permanent policies).
Then an agent goes through the pros and cons of each type of policy. We want you as a client for life and will never recommend a policy that doesn’t suit you regardless of the commission involved.
In the end, you get a policy that provides you with adequate coverage, fits your situation and we may even save you thousands of dollars over the term!
How Does Cash Value Life Insurance Work Anyway?
A Life insurance policy that has an investment and a savings component is known as cash value life insurance.
Over time, you deposit extra money inside a life insurance policy above and beyond what the actual insurance is costing you. This extra cash can grow in value providing you with a number of options down the road.
People who decide to build up cash value in a life insurance policy are essentially overpaying their insurance premiums over a long period of time (sometimes short) to create a nest egg inside their policy.
Any cash value inside the policy grows tax sheltered or even tax-free, depending on whether the money is touched before the insured dies or paid intact to beneficiaries.
Life insurance is something that can have tremendous benefits for your loved ones in the event of your death. Some people wonder if life insurance is a smart investment, and if so, which types of insurance make the most financial sense. This depends greatly on the specifics of your personal financial situation. Is Life Insurance a Good Investment, Lendedu.com
So Which Life Insurance has Cash Value?
If you’re wondering which life insurance has cash value, I’m gonna make a long story short!
The only vehicles that offer cash value life insurance are permanent life insurance policies.
From there it can get pretty complex.
Permanent life insurance isn’t for the faint of heart.
Be suspicious of any agents that try to sell you one of these policies right out of the gate without a complete understanding of your situation. You need to go through all of your options with an experienced independent agent if this is the road you decide to take because there are a LOT of points to consider.
There are two types of permanent insurance policies that offer a cash value component:
- Whole Life insurance, and
- Universal life insurance
In some ways, they are very similar in that they are designed for a permanent need and offer coverage for life rather than a specific term…
…but there are also Big differences!
So let’s check them out now:
How Does a Whole Life Insurance Policy Work?
Go get a cuppa a Joe and I'll fill you in!
When you think of cash value life insurance, whole life is the first product that comes to mind. In fact, whole life is the original cash value life insurance policy. It’s also the best-known type of permanent life insurance on the market.
If you’re looking for coverage until the day you die, whole life insurance gives that to you. As long as you pay your premiums, your death benefit will be paid out. Whole life is known as permanent insurance because you pay level premiums for the life of the policy.
The monthly cost you’re quoted is guaranteed to remain the same no matter what, even if your health deteriorates.
A Whole life insurance policy lets you build up guaranteed cash value over time. Borrowing against the cash value of your policy is one of the perks.
Whole life is also known as a “bundled” insurance product which means the insurance company decides how the cash inside your policy is invested. Because the insurance company is accepting the risk of choosing the investments, they’re willing to guarantee the return on the cash value invested inside your policy.
Explaining Cash Value Life Insurance: Whole Life
So if you’re wondering how this all works you’re not alone.
Basically, each month when you pay your premium, a portion of it goes to fund the insurance cost of your policy. The remainder is put towards the cash accumulation component. The more excess money leftover after insurance costs are paid, the larger the cash value becomes. Over time, it can accumulate into a substantial nest egg.
In the early years of the policy, you build up more cash value in your policy because the pure cost of insurance is lower. In the later years, a higher percentage of the premium (sometimes all of it) is used to cover the insurance costs.
The cash value built up in the policy at this point supplements the cost of insurance. In effect, the monthly premiums remain level but the portion required to pay the cost of insurance goes up substantially.
To optimize the growth potential of cash value life insurance, some people maximize the money they put into the policy in the early years. They accomplish this by electing to pay up the policy over a shorter time period: 10, 15 or 20 years. Because you’re paying faster, your premiums are substantially higher.
The good news?
When finish paying after 20 years, that’s it! You no longer pay any more premiums and the cash value inside your policy continues to compound guaranteed.
How Does a Universal Life Insurance Policy Work?
Now that's a great questions too, let's dig in!
Universal life insurance is similar to whole life in that it’s permanent insurance. Like whole life, a universal life policy has two components:
- an insurance portion, and
- an investment portion
Premiums are split between these two elements, one portion pays the pure cost of insurance and the residual is deposited into an investment account.
Unlike whole life, the premium can be adjusted over time and during the life of the policy. This means, within prescribed limits, you can choose how much extra cash to dump into the investment portion of your policy. By adjusting your premiums, you are also adjusting the death benefit. Now, this is pretty cool.
This means as your financial situation changes you may deposit more money into your policy. Conversely, you may opt to take a break from paying premiums altogether. As long as there’s enough cash value in the policy to cover the cost of insurance, your coverage won’t lapse.
Cash Value Life Insurance - Universal Life Strategy
One strategy some people use is to stuff the maximum amount of cash into their policy in the early years to optimize tax-deferred growth.
Like whole life, you can borrow against the cash value of your policy and any growth inside the investment portion is tax-deferred.
Universal life is an “unbundled” insurance product. This means you get to choose how the cash value inside your policy is invested. Your options include a wide range of asset classes. This gives you the ability to manage your investment mix and adjust it over time. Because you’re accepting the risk of how the money is invested, the death benefit and cash value are not guaranteed.
Unlike other products, such as term and whole life, universal life — which is permanent, cash-value life insurance — allows buyers to make flexible premium payments. That flexibility allows buyers to fund policies with a relatively low amount of premiums to keep the insurance going. However, a cost increase could leave these clients with an unattractive choice: pay a much higher annual bill to keep the contract afloat or lapse the policy altogether. Universal Life Insurance Lawsuits Underscore Product Risk
Explaining Cash Value Life Insurance: Universal Life
Universal Life seems complicated because of its flexibility and choices…and it is.
As I mentioned above its similar to whole life. A portion of each month’s premium goes to pay the pure cost of insurance. The remainder is deposited in the cash accumulation account.
The more you overpay your premiums, the more money there is to compound and grow tax-deferred. If you’ve made good investment decisions, the growth can be substantial. Likewise, if you choose poorly your cash value will sink like the Titanic. This option isn’t for people who want to set their policy and forget it!
Early on, just like whole life, you build up more cash value in your policy because your pure insurance costs are lower. Later on, a higher percentage of the premium is required to cover the insurance costs. Again similar to whole life, any cash value built up in the policy may be used to supplement the cost of insurance.
But there are differences...
However, unlike whole life insurance, universal life insurance premiums don’t necessarily remain level.
Above the minimum amount required to cover the cost of the insurance component, YOU decide how much you want to overpay. For example, you could begin paying $200/ month and then in 6 months decide you want to pay $350/ per month. Or, you could make a one-time large deposit into your policy, in addition to what you’re paying monthly.
Beware! There’s a formula that dictates the maximum amount of cash you may deposit annually – but we don’t need to go into those details here.
To maximize the growth potential of universal cash value life insurance, some folks stuff as much dough as possible into their policy as quickly as they can. By depositing larger sums of money over shorter periods of time, they’re in essence creating a version of paid-up whole life insurance.
Investing Isn't for Everyone!
The difference being, you’re in charge of how much cash to put in and where the money in their policy is invested. You have a lot more control in this situation. Also if your financial outlook changes you have the flexibility to adjust your payments accordingly.
…BUT you need to market savvy. If you’re not you could get seriously burned.
So let’s say you are a hands-on investor and feel comfortable with these choices. To accelerate even more growth, you may choose to put a large portion of your policy investment account into indices tied to equities (ie. large US Cap)…
…OR if you’re more conservative, you may choose GIC’s or bond markets.
Remember, because you’re the one who decides how your money is invested, you take on the risk. The insurance company provides you with NO guarantees on growth.
Hey I currently have a cash value life insurance policy that's not working for me! NOW what??
Well you're not alone. Unfortunately a LOT of people get into these policies and want out.
What is The Cash Surrender Value of Life Insurance?
The cash surrender value of life insurance (CSV) is the amount of money the insurer will refund you in the event you decide to cancel your policy…
…or, if you use your policy as collateral for a loan, your financial institution will allow you to borrow a percentage of whatever the current CSV is. If you increase the amount of cash you’re putting into your policy, the cash surrender value increases as well.
Generally, there are restrictions on taking money out of your policy too early and it may take years to see any substantial growth. Many people mistake the cash surrender value of life insurance for the death benefit or coverage amount. The CSV is always lower in value than the death benefit.
If you have any questions about the cash surrender value of your policy give us a call today. We can help you sift through your options.
The Pitfalls of Cash Value of Life Insurance
…and yes there are many! as I mentioned before cash value life insurance only works for a limited cross-section of consumers. The majority of the policies we sell at Policy Architects are Term.
This is because Term Life Insurance is cheap, flexible and gets the job done with very little hassle.
So here are my top gripes when it comes to Cash Value Life Insurance!
Cash Value Life Insurance Takes TIME to Build Cash Value!
Ladies and Gentlemen, it takes time to build up your money inside a permanent policy regardless of whether it’s universal or whole life. This is one of the biggest drawbacks of permanent life insurance. Way too many people let their policies lapse early on because the premiums are so costly. Sadly the result is they basically forfeit their whole investment if they don’t reach a certain point.
“Some studies claim as many as 80 percent of policies will lapse before a payout is due…According to the 2009 LIMRA report, close to 12 percent of whole life policies lapse in the first year and 10 percent lapse in the second year.”
Cash value life insurance works much better for people with substantial resources, who’re able to follow through with their premiums into the later years.
NOTE* Although this post is focused on cash value life insurance, it is possible to buy a permanent life insurance policy that pays the pure cost of insurance only. These permanent policies include Term to 100 and Guaranteed Universal Life. They typically offer level premiums for life along with a level death benefit.
Commissions and Administrative Costs are HIGH for Cash Value Life Insurance
It’s no secret that high commissions and administrative costs are attached to cash value life insurance products. That’s one of the reasons it takes so much time to build up the cash value in a permanent policy!
Not all the money you are paying goes to the cost of insurance and the cash accumulation. Buyer beware! This is another reason you should consult an independent life insurance agent.
Cash Value Life Insurance is Expensive - Which Means You Could be Underinsured
When people ask me why I like Term Life Insurance so much one of the main reasons I give is the high face value. Because Term is so affordable my clients are able to purchase the coverage they need – not just the coverage they can afford.
If you are in you’re a 39 year old man in standard health you can get $1 million of 30 year term coverage for about $175.00 per month! On the other hand, if you’re that same 39 year old man, you’ll pay $1310 per month for $1 million of Whole Life 20 Pay enhanced coverage from Equitable Life.
Wow, this is a very big difference, more than 7 times as much!
The thing is, you have to remember that with the Whole life policy you’re guaranteed a payout…
BUT remember, you have to be able to afford these very expensive payments every month for 20 years! If your financial situation changes this could be VERY bad news for you and your family.
Honestly, most people want life insurance coverage to protect their family members or business partners from loss of income. These needs change as you get older. In my opinion, it’s far better to have adequate coverage for the period you need it.
A sizable portion of U.S. adults are not buying life insurance because in many cases it is too expensive, according to a new study.
Almost two-fifths of Americans (37 percent) do not have a life insurance policy, according to a recent survey sponsored by InsuranceQuotes, with the most commonly cited reason being that they cannot afford it. Why Many US Households Don’t Own Life Insurance, Financial Advisor
So Is Cash Value of Life Insurance Right For You?
Ok, so you got this far… now you want to know, is cash value life insurance right for me?
The short answer, probably not…
But it depends on your personal financial situation.
Here are three situations where a Cash value life insurance policy would be beneficial for you!
You’re a high-net-worth individual set for a solid retirement!
You’ve maxed out traditional retirement vehicles including your pension, RRSP’s and TSFA’s. You likely own real estate and have non-registered investments in excess of a million dollars.
You also pay tax at the highest marginal rate and as you get older and you can see the writing on the wall. When you’re gone, the government will take more of your hard-earned wealth than your family – over 50% in the form of taxes.
OOOF! For some families, this could be millions of dollars.
Is there a way for you to pay less tax and have more of your estate go to your loved ones?
Cash Value Life Insurance: Insured Retirement Plan
Absolutely, it’s called an Insured Retirement Plan (IRP). In some circles, it’s known as leveraging.
In a nutshell, an insured retirement plan involves purchasing a permanent cash value life insurance policy and overfunding it in the shortest period of time feasible (often 7-10 years).
The IRP strategy may be accomplished with either a whole life or universal life insurance policy. All the money deposited into the investment account of the policy, will compound and grow on a tax-sheltered basis.
When you reach retirement you may require extra money above and beyond what your pension and investments are bringing in. Instead of withdrawing cash from the investment account in your policy, you take out a series of loans using your policy as collateral.
Because you’re not actually taking money directly out of your policy, no income tax is triggered. The best part? The investment account remains intact and continues to compound tax-free.
They aren’t joking when they say money begets money.
So What Are The Advantages Of An Insured Retirement Plan?
- Tax-Free Growth: All the money deposited in your cash value life insurance policy grows on a tax-sheltered basis.
- Tax-Free Retirement Income: Using the investment account in your policy as collateral for a loan, you in effect take money out of your policy without triggering taxes, as loans aren’t taxable.
- The policy loan and interest are paid off tax-free out of the death benefit. When you die, any money remaining goes to your beneficiaries tax-free.
Your Business is A Cash Cow!
If you have excess cash in your business or corporation that you want access to without being taxed at high rates, an Immediate Financing Arrangement (IFA) may be for you.
This strategy is suitable for businesses who want tax-sheltered growth but want to access their cash for operations and to produce income at the same time.
Similar to an insured retirement plan, an IFA allows small businesses and corporations to basically dump a pile of money into a cash value life insurance policy and immediately borrow it back.
This accomplishes a few things:
Cash Value Insurance: Immediate Financing Arrangement
- It covers you for future tax liabilities and allows you to get your insurance at a fraction of the real cost while maintaining cash flow for your business or property. The money you borrow back can be used to invest and produce income.
- The investment component of the life insurance policy remains untouched and grows on a tax-free basis.
- Because the premiums are paid from corporate dollars (after-tax) instead of from your own pocket, you save big on taxes.
- You can deduct the interest expense on the loan and the Insurance expense portion of the policy.
- Upon death, almost all of the policy proceeds can be paid to the shareholders estate tax-free
If eligible, An Immediate Financing Arrangement allows you in some cases to borrow up to 90% of the Cash Surrender Value (CSV) of your policy.
So wait a minute, let me get this straight!
If you have a business or corporation you can:
- Purchase a gigantic cash value life insurance policy
- Immediately borrow a large portion of the money back tax-free
- Invest the cash back into your business to produce more income
- Deduct the interest cost from your taxes since you’re investing the proceeds of a loan
- Deduct the pure cost of insurance from your taxes
- Watch the investment account inside the policy grow tax-sheltered
- Substantially increase the size of your estate
- Cover any estate taxes payable upon your death
- Leave more money for your beneficiaries
Yes, absolutely! So, if you’re in this situation, a cash value life insurance strategy is definitely worth checking out.
You Want to Keep the Family Cottage in the Family
As you know I don’t think a cash value life insurance investment is necessarily the wisest financial move.
However, if you’re fortunate enough to own a family cottage, you appreciate all the wonderful things that go along with it.
Relaxing outdoors, sunsets by the dock and family traditions like playing board games inside when it’s raining.
…but it’s also a constant source of maintenance.
Although it’s a great way to keep the family connected it’s costly!
…and when you die it may become a tax liability.
Sure escalating valuations on homes are a boon but what happens when the tax man visits after your death? Will your family be able to hold on to the memories?
After Your Death Your Cottage or Investment Property May Become a Tax Liability
Unlike your family home which has no tax liabilities, your cottage is categorized as an investment property subject to capital gains taxes.
Without a plan to deal with this tax liability, your family could be put in the devastating position of having to sell the cottage.
If your cottage was purchased 20 years ago for $120,000 and now it’s worth $600,000, it has a capital gain of $480,000. If you transfer ownership of the cottage to your children, approximately 25% of that capital gains must be paid as tax. That’s $120,000.
My guess is you want to make make sure your kids don’t get stuck with $120,000 tax bill. The alternative may be that they have to sell the cottage to pay the taxes.
One solution is to purchase a “joint last to die” cash value life insurance policy. This means you and your spouse are listed on the policy together and the death benefit is paid out after the 2nd death when it’s needed.
Typically, when the first spouse dies, ownership of the cottage rolls over to the remaining spouse with no tax triggered. Upon the death of the remaining spouse (last-to-die) the death benefit is paid out providing the necessary cash to cover the tax bill.
It some situations, it may help diffuse the burden if the children chip in on the life insurance premiums, after all, they’re the ones inheriting the cottage.
Do You See A Trend Or Pattern Here? Cash Value Life Insurance has Pros and Cons!
This is just a taster of cash value life insurance. But I think you can see a trend right?
In all of these examples, cash value life insurance is used by wealthy individuals to eliminate tax problems!
It's not used to cover traditional loss of income.
Hmmmm...Maybe a better name for this product would be cash value tax insurance!
All humour aside this is why I recommend using Term Life Insurance for almost all of my clients...
...Unless we are talking about final expense insurance or guaranteed issue life insurance.
Cash Value Life Insurance Is a Great Tool BUT...
Cash value life insurance is a tool best used to minimize tax liabilities and not necessarily the best one for the basic protection of your family.
This product is something I would recommend if you’re:
- A high a high net person or successful business owner. An insured retirement plan is best used by individuals who already have funds for retirement and have the cash to spare.
- A profitable business owner with surplus money to invest. If that’s the case an immediate financing arrangement may be something worth taking a look at.
But alas for most of us, term life insurance is your best option.
As I mentioned above there are some exceptions:
- A small cash value policy is ideal to take care of final expenses or some capital gains tax on a family cottage
- If you’re unwell and are looking for guaranteed issue life insurance this can be worth considering
- If you want to establish a trust to provide your disabled child with lifelong financial support after you are gone
- Gifting a life insurance policy to your child guarantees insurability and some protection
- Other estate planning purposes which require the advice of a financial advisor or an independent life insurance agent
Why You Need to Speak to Policy Architects Today!
Well, we’ve reached the end, my friends! I know it’s not the most scintillating topic but it sure is important. This info can save you a bomb AND eliminate frustration down the road if you’re aware of it BEFORE you speak to an agent.
Hopefully, you now understand:
- What cash value life insurance is
- Which life insurance has cash value
- What the cash surrender value of life insurance means for you, AND
- That cash value life insurance ain’t for everyone.
As you can see cash value life insurance sure is a complicated product!
…and quite honestly I didn’t even get into all of it. I used broad strokes to make it clear to you that Cash Value Life Insurance doesn’t work for the average person.
Hey, don’t get me wrong! I sell a lot of final expense and guaranteed issue insurance. These are permanent products but they are geared towards very specific needs.
If you’re looking to protect your family from a loss of income and want to be insured properly, then please check out Term coverage. There’s nothing better than being able to travel and sleep well knowing that for the next 10, 20 or 30 years you’ll be protected.
...BUT If You're Still Interested in Cash Value Life Insurance
Then you absolutely need to speak to an independent life insurance agent. Protecting the family cottage, getting the most out of your business and estate planning are all areas that Policy Architects can help you.
Not all life insurance companies are created equal, so make sure you’re investing wisely. We know the ins and outs of all the top insurers and will get you the best possible policy at the best possible rates.
Call today! 1.888.501.9583!