Most people are aware that life insurance offers a death benefit. After all, that’s why they take out the policy. But did you know that some life insurance policies also offer a cash value portion? This less-well-known feature has some really significant advantages that you definitely want to be aware of if you’re considering taking out a life insurance policy.
Both permanent life insurance and term life insurance offer a death benefit. This is the lump-say payment that goes to your heirs after your death. Monthly premiums fund this benefit, which protects loved ones in your life who wouldn’t be able to financially support themselves in the event of your death.
But using life insurance solely for this purpose is like using a microwave only to boil water. It’s capable of doing more than that—and you can really gain some serious advantages by learning how to capitalize on all of the product’s features.
Life Insurance Cash Value
In addition to the death benefit, some permanent life insurance policies come with a cash value feature. It’s important to note that term life insurance never offers it.
The way the feature works is that as you pay your premiums, a portion of this cash flow is set aside in a separate investment account. The more premiums you pay, the larger this account becomes. Plus, it earns interest over time, further increasing its value.
Using the Cash Value
Most life insurance policies will allow you to use the cash value (before your death) in several ways.
Collateral for a loan: Many life insurance companies will let you borrow up to your current cash value; and doing so usually isn’t a taxable event. Like other loans, the amount borrowed must be repaid; otherwise, the death benefit will be reduced. As with other loans, a loan against cash value accrues interest.
If you’re running your own business, it may also be possible to use this loan feature to lend money to your small business. The business then could pay you back with interest and deduct its interest expense on its next tax return.
Withdraw the cash: Instead of borrowing against the cash value, you can simply withdraw it. As with the loan, this option is usually tax free. The one exception is when a withdrawal is greater than the amount of the cash value. A withdrawal of any amount reduces a policy’s death benefit.
Use the cash value to cover premiums: If you ever find yourself stretched to the limit in a particular month, you could skip paying your life insurance premium and pay it instead using the cash value in your policy. The number of times you can do this, however, is limited by the total amount of cash value.
Cancel a policy for its cash value: It’s also possible to surrender a life insurance policy altogether for its entire cash value. Choosing this option does come with surrender fees, and it may entail income taxes as well.
Cash Value Grows Over Time
Because the cash value portion of a life insurance policy earns interest, it is able to compound significantly over time, especially over a long period of time. Paying premiums also increases the cash value position. Even better, the growth is tax deferred.
Different insurance policies invest cash balances in different ways. A variable life insurance policy, for example, invests the cash value in subaccounts, which are similar to mutual funds. A universal life policy, on the other hand, determines the growth of cash value by prevailing interest rates.
It’s important to take advantage of everything a policy’s cash value offers because once the policyholder passes away, the cash value is surrendered to the life insurance company. Except when it isn’t.
It’s possible to purchase an insurance supplement called a rider. There are riders for all sorts of amendments. One rider, for example, will pass both the cash value and the death benefit to the beneficiary named in the policy. This is a good way to capture the full upside of cash value; although buying the rider obviously increases the cost of insurance. Other riders allow you to increase the cash value of a policy using various methods.
Learning to Use Life Insurance as a Financial Vehicle
Although life insurance can and should be an integral part of estate planning, it can also be used to improve your family’s financial situation in the near term. The cash value of a life insurance policy could be an ideal way to handle an emergency, for example. And it’s possible to tap into it using tax-advantaged methods.
By incorporating into your financial plan all the resources life insurance offers you, you’ll gain more financial strength now rather than solely at the end.
If you need any assistance managing your insurance policies within the context of your overall financial picture, contact a Glass Jacobson insurance specialist today.