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How do life insurance policies build cash value?

Here's what you need to know...
  • Not all life insurance policies have a cash value but those policies that do are said to have a living benefit and a death benefit
  • Cash value policies are called permanent life insurance plans and include both a pure life benefit and an investment component
  • Whole life, variable life and universal life insurance policies all accrue a cash value as premiums for pure life and cash accumulation are paid
  • The premiums are divvied up and a portion will pay the pure life insurance charge, another portion will pay for operating fees and the last portion will go into the cash account which earns interest
  • In the first years of the policy, after inception fees are paid, cash value will grow rather quickly because the insurance charges are lower
  • The way cash values grow depends on type of insurance

Life insurance is typically purchased with the intention of providing your loved ones with a death benefit that can help them pay off debt and maintain their lifestyle once you’re gone. While the primary focus is placed on the death benefit, there are also policies that provide the policy owner access to cash values. This cash accumulation that’s built into a life insurance policy is a living benefit that’s offered separate from the death benefit. Compare life insurance rates now by using our FREE tool above!

If you’re not familiar with life insurance or you’ve only ever taken the time to learn about traditional term life, you might be surprised to learn that nearly 32 percent of the policies issued have a living benefit. These policies are called permanent life insurance plans or cash value plans. If you’d like to understand how the savings component works and how cash values act as living benefits, read this guide.

What’s the difference between term life and permanent life?

Not all types of insurance have cash values. When you pay for term life insurance, which comes with affordable premiums, the basic policy offers strictly a death benefit. In order for the insurance to pay the death benefit, the insured must pass away while the term is still in force.

If you don’t pass away during the term, the money is the companies and you’ll need to reassess your life insurance portfolio needs.

Permanent insurance is very different because it doesn’t have an expiration date. Instead, the policy has a pure life component that doesn’t expire and a savings component that earns interest and partially covers the rising cost of insurance as the insured ages. This is why permanent policies need cash accounts to stay in force whereas a term policy doesn’t.

What types of policies fall into the permanent life category?

There’s more than just one type of permanent life insurance plan that you can purchase. It’s important that you know which policies fall into the permanent umbrella and which don’t if you’re trying to distinguish cash value plans from pure life plans. Here are the current policies that are sold by individual life carriers that include an investment or cash value component:

Why are permanent life insurance policies more expensive than term life policies?

There’s two reasons why permanent life will cost you significantly more in premiums for the same exact amount of coverage. The first reasons is because you’re buying coverage that will last a lifetime so the mortality charges on the policy will fluctuate. Since these charges fluctuate, the company must add up the mortality charge and divide it throughout the life of the policy, making the cost of pure life insurance under a permanent plan higher than the cost for term.

The longer you’re transferring risk to your insurer, the more the cost.

The second reason that permanent insurance costs more is because you’re not just paying for the cost of life insurance and administrative fees. You’re also paying for the investment component that essentially keeps the policy going without leading to exorbitant charges. This tax-privileged cash account accrues interest which can grow or be applied to the policy to balance the premiums.

How does the cash value grow in each policy?

The way that cash accounts grow depends on the type of policy you purchase. Since each policy is structured differently and companies use different investment strategies based on the policy type, you can’t expect cash values to build-up the same all across the board. Here’s a breakdown of how different permanent policies accumulate cash value in very different ways:

  • Whole Life Policies: Whole life was the first type of permanent insurance offered and is still a very popular choice today because of its guaranteed cash value accounts. With a whole life policy, you know exactly how much you’ll pay for coverage and you’ll be able to see just how the policy grows in a company illustration. Since there’s a fixed premium and guaranteed schedule where the values grow, whole life policies are great for clients who enjoy certainty. To make this possible, companies collect a fixed premium each policy year. A portion goes to the life coverage, another to fees, and the last portion goes to the cash account where there’s a promised interest rate.
  • Universal Life Policies: Universal life policies are more flexible than whole life policies. Unfortunately, this flexibility can make universal life plans dangerous for people who don’t manage the performance. Since the payments can fluctuate and you can decide how to fund your policy, there’s no guaranteed cash account growth. Instead, there’s a minimum interest rate you’re promised but actual interest is based on current trends. If you fund the policy with extra funds, those extra funds will sit in the cash account where they will grow.
  • Variable Life Policies: Variable life policies are a lot like mutual funds that come with a life insurance benefit. When you buy a variable policy, there’s a lot more risk tied to the plan because cash values can grow quickly or even decline based on the performance of bonds and mutual funds that you choose. You must be willing to take a loss and lose your death benefit entirely when you choose a variable life plan.

What can you do with your cash values?

Cash values sit in your policy until you decide what you want to do with them. You have the option to use them while you’re living by taking them out in the form of a loan or withdrawing them.

Be sure you know the tax consequences and how your choice can affect the payment of life proceeds to your beneficiary.

Not everyone wants a policy that builds cash value, but if you’re looking for a permanent benefit to pay beneficiaries, it might make sense for you. Make sure that you take a look at the price of cash value insurance by using a quote comparison tool. Once you know pricing options, you can decide what’s realistic for you. Enter your zip code in our FREE tool below to compare life insurance rates instantly!