Fact CheckedAre you wondering how cash value life insurance works? Or maybe you want to know which life insurance has cash value.
If so, you’re one of many.
Cash accumulation is a topic that comes up a LOT in my business.
Most people who think they want a whole-life policy cite the cash value component as the main reason.
…and I can’t blame them.
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. But there are exceptions to this statement.
So, if you want to find out which life insurance has cash value and whether this is the right move for you and your family, read on!
How Does Cash Value Life Insurance Work Anyway?
A Life insurance policy with 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 insurance costs you. This extra cash can grow in value, providing you with several 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 (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 is paid intact to beneficiaries.
“Life insurance provides five financial benefits for you and your family. The main benefit of adding life insurance to your financial plan is that if you pass away, your heirs receive a lump sum, tax-free payout from the policy. They can use this money to pay your final expenses and to replace your income. Life insurance can also benefit you while you’re still alive. Some policies pay out if you develop a chronic/terminal illness and some provide savings you can use to support your retirement.”
So, Which Life Insurance has Cash Value?
If you’re wondering which life insurance has cash value, I will 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 who try to sell you one of these policies without fully understanding your financial situation.
If you decide to take this route, you need to discuss your options with an experienced independent agent because there are many points to consider.
Two types of permanent insurance policies offer a cash value component:
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:
Whole Life vs Universal Life
When you think of cash value life insurance, whole life is the first product that comes to mind. 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 provides that. Your death benefit is paid out as long as you pay your premiums.
Whole life is known as permanent insurance because you pay level premiums for the policy’s life.
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. One of the perks is the ability to borrow against your policy’s cash value.
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 accepts the risk of choosing the investments, they’re willing to guarantee the return on the cash value invested in your policy.
Explaining Cash Value Life Insurance: Whole Life
So, if you’re wondering how this all works, you’re not alone.
When you pay your premium each month, a portion of it funds the insurance cost of your policy.
The remainder is put towards the cash accumulation component. The more excess money left after insurance costs are paid, the larger the cash value. Over time, it can accumulate into a substantial nest egg. In the early years of the policy, you build up more cash value 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.
At this point, the cash value built up in the policy supplements the insurance cost. The monthly premiums remain level, but the portion required to pay the insurance costs increases substantially.
Some people maximize their money into cash-value life insurance in the early years to optimize their growth potential.
They accomplish this by electing to pay up the policy over a shorter period: 10, 15, or 20 years. Because you’re paying faster, your premiums are substantially higher.
The good news?
When you 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 as guaranteed.
Looking For Whole Life Insurance Quotes?
“FUN FACT: Equitable Life has the best performing whole life policy in the Canadian marketplace today.”
How Does a Universal Life Insurance Policy Work?
We started by asking which life insurance has cash value—we know whole life does, but that’s not all!
Universal life insurance is similar to whole life in that it’s permanent insurance. Like whole life, a universal life policy has two components:
- insurance portion, and
- investment portion
Premiums are split between these two elements. One portion pays the pure insurance cost, and the residual is deposited into an investment account.
Unlike whole life, the premium can be adjusted over time and during the policy’s life. This means that 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.
As your financial situation changes, you may deposit more money into your policy.
Conversely, you may opt to stop paying premiums altogether. As long as the policy has enough cash value to cover the insurance cost, your coverage won’t lapse.
Cash Value Life Insurance: Universal Life
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 your whole life, you can borrow against your policy’s cash value, and any growth inside the investment portion is tax-deferred.
Universal life is an “unbundled” insurance product. This means you can choose how the cash value inside your policy is invested.
Your options include a wide range of asset classes, which allows you to manage and adjust your investment mix 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.”
Explaining Cash Value Life Insurance: Universal Life
Universal Life seems complicated because of its flexibility and choices…and it is.
As I mentioned above, it’s similar to whole life insurance. A portion of each month’s premium pays the pure cost of insurance, and 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’s. This option isn’t for people who want to set their policy and forget it! Early on, just like your whole life, you build up more cash value in your policy because your pure insurance costs are lower.
Later, a higher percentage of the premium is required to cover the insurance costs. Again, like whole life, any cash value built up in the policy may be used to supplement the insurance cost.
Which Life Insurance Has Cash Value? There are differences…
However, unlike whole life insurance, universal life insurance premiums don’t necessarily remain level.
You decide how much to overpay above the minimum amount required to cover the insurance component.
For example, you could begin paying $200/ month and then decide to pay $350/month in 6 months.
Or, you could make a one-time large deposit into your policy in addition to what you’re paying monthly.
Beware! A formula dictates the maximum amount of cash you may deposit annually, but we don’t need to discuss those details here.
Some people invest as much money as possible into their universal cash value life insurance policies to maximize their growth potential.
They create a version of paid-up whole life insurance by depositing more significant sums over shorter periods.
Investing Isn’t for Everyone!
The difference is that 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 can adjust your payments accordingly.
…BUT you need to be 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 growth, you may put a large portion of your policy investment account into indices tied to equities (e.g., large US Caps).
…OR if you’re more conservative, you may choose GICs or bond markets.
Remember, you take the risk because you decide how your money is invested. The insurance company provides no guarantees on growth.
What is The Cash Surrender Value of Life Insurance?
The cash surrender value of life insurance (CSV) is the amount of money the insurer refunds you if you cancel your policy…
If you use your policy as collateral for a loan, your financial institution will allow you to borrow a percentage of the current CSV. The cash surrender value also increases if you increase the cash you put into your policy.
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.
Call us today with questions about your policy’s cash surrender value. We can help you understand your options.
The Pitfalls of Cash Value of Life Insurance
…and yes, there are a few! Cash-value life insurance can be a great tool, but it’s not for everyone. The majority of the policies we sell at Policy Architects are Term.
Term Life Insurance is cheap, flexible, and does the job with minimal hassle.
So here are my top gripes when it comes to Cash Value Life Insurance!
1. 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. So, in this respect, it does not matter which life insurance has cash value.
This is one of the most significant 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 that they forfeit their whole investment if they don’t reach a certain point.
Ouch!
Cash value life insurance works much better for people with substantial resources who can afford to pay their premiums in later years.
NOTE* Although this post is focused on cash value life insurance, buying a permanent life insurance policy that only pays the pure insurance cost is possible. These permanent policies include Term to 100 and Guaranteed Universal Life. They typically offer level premiums for life along with a level death benefit.
In other words, you’re paying for the insurance’s pure cost, nothing more, nothing less.
2. Commissions and Administrative Costs are Higher 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 reason it takes so long to build up the cash value in a permanent policy!
Yep.
Not all the money you pay goes to the cost of insurance and cash accumulation. Buyer beware! This is another reason you should consult an independent life insurance agent.
3. 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 can purchase the coverage they need – not just the coverage they can afford.
If you’re a 39-year-old man in standard health, you can get $1 million of 30-year term coverage for about $175.00 monthly!
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 big difference, more than seven times as much!
Remember that with the Whole life policy, you’re guaranteed a payout…
But you must be able to afford these costly monthly payments for 20 years! If your financial situation changes, this could be terrible news for you and your family.
Most people want life insurance coverage to protect their family members or business partners from income loss.
These needs change as you age. It’s far better to have adequate coverage for the period you need.
“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
Now that we have determined which life insurance has cash value, is it right for you?
Okay, so you’ve made it this far. Now you want to know: Is cash value life insurance right for me?
The short answer is probably not…
But it depends on your financial situation.
Here are three circumstances where a Cash value life insurance policy will benefit you!
1. You’ve Got Money To Burn!
The question of which life insurance has cash value isn’t that important to you…
…because you’re a high-net-worth individual set for a solid retirement! You have cash and need a little help setting up some tax-savvy shelters.
You’ve maxed out traditional retirement vehicles, including your pension, RRSPs, and TSFAs. You likely own real estate and have non-registered investments of over a million dollars.
You also pay tax at the highest marginal rate, and as you age, you 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 taxes.
OOOF! For some families, this could be millions of dollars.
Can you pay less tax and have more of your estate go to your loved ones?
2. Cash Value Life Insurance: Insured Retirement Plan
It’s called an Insured Retirement Plan (IRP), and 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 feasible (often 7-10 years).
The IRP strategy may be accomplished with a whole life or universal life insurance policy. The money deposited into the policy’s investment account compounds and grows tax-sheltered.
When you retire, you may require extra money above and beyond what your pension and investments bring.
Instead of withdrawing cash from the investment account in your policy, you take out a series of loans using your policy as collateral. Many life insurance companies will attach a line of credit (LOC) to your policy at competitive interest rates.
No income tax is triggered because you’re not withdrawing cash directly from your policy. 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: By using the investment account in your policy as collateral for a line of credit, you can, in effect, take money out of your policy without triggering taxes because, according to the CRA, loans are NOT taxable.
- The policy loan and interest are paid off tax-free from the death benefit. When you die, any money remaining goes to your beneficiaries tax-free.
3. 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 suits businesses that want tax-sheltered growth but want to simultaneously access their cash for operations and produce income.
Like an insured retirement plan, an IFA allows small businesses and corporations to borrow money from a cash-value life insurance policy.
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.
- You save big on taxes because the premiums are paid from corporate dollars (after-tax) instead of your pocket.
- You can deduct the interest expense on the loan and the insurance expense portion of the policy.
- Almost all of the policy proceeds can be paid to the shareholder’s estate tax-free upon death.
If eligible, an immediate financing arrangement allows you to borrow up to 90% of your policy’s cash surrender value (CSV) in some cases.
So please 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! If you’re in this situation, a cash value life insurance strategy is worth considering.
4. 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 accompanying 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 also costly!
…and when you die, it may become a tax liability.
Sure, escalating home valuations 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 forced to sell the cottage, which would be devastating.
If your cottage was purchased 20 years ago for $120,000 and is now 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 gain 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.
The death benefit is paid out upon the death of the remaining spouse (last-to-die), 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 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 what cash value life insurance offers. But I think you can see a trend.
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 humor aside, I recommend using Term Life Insurance for almost all my clients…
…Unless we talk about final expense insurance or guaranteed life insurance.
Cash Value Life Insurance Is a Great Tool, BUT…
Cash-value life insurance is best used to minimize tax liabilities but is not necessarily the best option for protecting your family’s basic needs.
This product is something I would recommend if you’re a:
- High a high net individual: An insured retirement plan is best used by individuals with retirement funds and the cash to spare.
- If you’re a profitable business owner with surplus money to invest, an immediate financing arrangement may be worth considering.
- If you have a child with special needs, Consider establishing a Henson Trust to provide your disabled child with lifelong financial support after you are gone. This is a complicated topic that deserves its post.
- An individual with estate planning needs: A small cash value policy is ideal for covering final expenses or some capital gains tax on a family cottage.
- Someone who wants to gift a life insurance policy: To either protect your children in the future or offer them a nest egg to help buy a home, pay for an education, or start a business.
Sure, there are other estate planning purposes where cash value life insurance comes in handy…
…but I highly suggest speaking to an independent life insurance agent BEFORE making this decision.
Why You Need to Speak to Policy Architects Today!
Well, we’ve reached the end, my friends! You now know which life insurance has cash value (think permanent life insurance includes whole life and universal life coverage).
You also know that cash value life insurance is a specialized product.
I know it’s not the most scintillating topic, but it is crucial. Being aware of this information BEFORE you speak to an agent can save you a bomb and eliminate frustration down the road.
As you can see, cash value life insurance is a very complicated product!
…and quite honestly, I didn’t even get into all of it. I used broad strokes to clarify that Cash Value Life Insurance doesn’t work for the average person but does have its place.
Buy Term & Invest the Rest is the Approach That Works for 90% of My Clients
Hey, don’t get me wrong! I sell a lot of final expenses and guaranteed issue insurance. These are permanent products, but they are geared towards specific needs.
If you want to protect your family from income loss and be adequately insured, please consider Term coverage. It’s affordable, flexible, and works for most people.
Buying the term and investing the rest in other vehicles is your best bet.
There’s nothing better than being able to travel and sleep well, knowing that you’ll be protected for the next 10, 20, or 30 years.
… but if you’re high-net-worth and want to take advantage of the tax code, Cash Value Life Insurance could be a great option!
Policy architects can help you generate tax-free income during retirement, protect the family cottage, get the most out of your business, and plan your estate.
Not all life insurance companies are created equal, so make sure you’re investing wisely. We know the best-performing whole life insurance policies in Canada!
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