September 27, 2019
There are many different types of life insurance policies. Permanent life insurance policies are different than term life insurance. Permanent life insurance policies include whole life insurance, universal life insurance, variable life insurance, indexed life insurance, as well as group versions and survivorship versions of these policy types.
Permanent forms of life insurance have an investment feature whereby part of the premium payments, the amount greater than the insurance costs, are invested in a cash value account. The cash value component has many advantages, including a tax-deferred status, that makes cash value life insurance policies attractive to many policy owners.
Cash Value Insurance Policy Benefits
A policy holder with any of these types of policies may be able to leverage the accumulated cash value growth to take a loan against the value, withdraw some or all of the value, pay the policy’s premium with it, or surrender the policy back to the insurance company for some amount of the account value (in some instances for the full cash value). But what is the difference between account, or cash value, and the cash surrender value?
Cash and Account Value
The cash value (also known as account value) is designed to grow over time as long as the planned premium payment is maintained by the policy holder of a permanent life insurance policy. With a whole life insurance policy, the account value is designed to grow steadily by earning a dividend on the cash value. The dividend rate is set annually by the insurance company, but typically has a minimum guaranteed rate disclosed when you get your life insurance quote.
With a whole life type of policy, the policy holder cannot pay their premium payment with the account value but it is possible to borrow against the cash value of the policy. The loan amount that is borrowed from the policy is tax-free.
For universal life policies, there is more flexibility as to the amount of the premium payment. As long as the premium payment amount is more than the cost of insurance and expense charges, the policy’s cash value will grow steadily. The cash value in a universal life insurance policy grows when premiums paid into the policy are more than the monthly cost of insurance deduction earn an interest rate.
It is important to grow the cash value of a universal life insurance policy in the earlier years of the policy as the cost of insurance will steadily increase as the insured ages, and the cash value will help offset this increase. The policy holder can tap the account value of their policy by taking a loan against the policy with the insurance company or a partial withdrawal.
Cash Surrender Value
If a policy holder of a permanent life insurance policy no longer needs the life insurance coverage, the owner may also surrender the policy back to the life insurance company in exchange for the cash surrender value. The cash surrender value amount is the cash value (or account value) of the insurance policy less a surrender charge.
The surrender charge starts high, as it is a mechanism for the insurance company to recover their upfront underwriting and other costs of issuing the life insurance policy. The surrender charge goes down annually, typically going to zero in 10 to 20 years. In addition, if there was a policy loan taken out on the policy, that would reduce the cash surrender value as well. You can confirm these amounts with a quick call to your insurance agent or the life insurance company’s customer service line.
Depending on the type of life insurance coverage of the permanent policy, the cash value in the policy offers different investment options. Those investments could be in the life insurance company’s fixed account (universal life insurance policies and whole life insurance policies), mutual funds (variable universal life), or an index fund (indexed life insurance).
The rate of return earned may be variable and tied to market performance or can be a fixed rate interest or dividend payment. Many policies also have a minimum guaranteed return on the savings component. These rates will be disclosed when the policy is in underwriting.
Does Cash Value Life Insurance Work?
There are many valuable uses of cash value life insurance. The primary benefits are:
- Income tax deferral. The cash value grows inside the policy without any income taxes.
- Borrowing. Taking out a loan by borrowing against the cash value is a big benefit. There are no income taxes on the amount borrowed or the outstanding loan balance.
- Full life coverage. Term life insurance policies expire after the end of the term. Permanent policies provide full life coverage
Cash value insurance is a viable retirement planning tool and can be an alternative to an IRA.
What Happens If I No Longer Want My Policy
As opposed to a term life insurance policy that has no investment component, permanent life insurance policies have the cash value to consider if you no longer need the coverage amount of your life insurance policy. There are three basic options: lapse, surrender or sell.
Is taking a cash surrender value the best option for a policyholder who no longer needs the life insurance coverage? Not always. Many policyholders do not know that they may be able to sell their life insurance policy through a regulated transaction known as a life settlement.
Lapsing a cash value life insurance policy makes no sense, since, at a minimum, if you surrender your policy, you would receive the cash value less a surrender charge. Likely, the better option if you no longer need life insurance is to sell your policy in a life settlement transaction and realize the market value of your life insurance policy.
What is a Life Settlement?
A life settlement is the sale of a life insurance policy to an unrelated third-party. When you sell your life insurance policy in a life settlement, you receive a payout amount greater than the cash surrender value but less than the policy’s death benefit. Life settlement companies work with you to help you understand the entire life settlement process and determine whether your life insurance policy qualifies for a life settlement or viatical settlement.
After a policyholder sells a life insurance policy in a life settlement transaction, the policyholder is no longer responsible for life insurance premium payments. In addition, the policy’s beneficiaries and your loved ones will no longer receive the death benefit when the policy payout is made. You can use the cash payment received however you see fit, whether that is to supplement your retirement income, pay off debts and bills, or cover long-term care costs.
While a cash value life insurance policy may have been a great investment at the time it was taken out, your client’s situations change and plans change. The life insurance companies, like New York Life, don’t want you to tell your clients about this great alternative. In fact, selling a life insurance policy in a life settlement can result in you receiving 3-4 times the policy’s cash surrender value.
If you’re interested in receiving a quick and easy estimate on the potential value of your client’s policy, get an ‘instant’ quote directly from our online calculator page! For more information, please call 888-388-0988, contact us, schedule an appointment, or email us at firstname.lastname@example.org.