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A permanent life insurance policy, which may also be referred to in the industry as a cash value policy, is much more complex than the stand term insurance plan. Instead of offering a fixed death benefit for a specific period of time, a permanent life plan offers a death benefit that can grow and accumulate value as the premiums are paid. The benefit will grow as the net cash account values rise all while the premiums stay level. Start comparing life insurance rates now by using our FREE tool above!
Since a permanent policy remains active for the entire life of the insured, the value of the policy can grow significantly as the insured ages and maintains their payments. This can be an attractive feature of permanent insurance for some and a cause of confusion for others who do not take the time to learn about the product. If you are interested in learning about policies that provide both lifelong life insurance protection and accumulating cash values, read this guide and learn just what net cash values are and why they are important.
What are the biggest benefits of buying permanent life insurance?
The biggest benefit of permanent life insurance is that the policies provide the named insured with a permanent death benefit for as long as they live at rates based on the age they were at the time of application. While this is a huge incentive, another huge advantage to buyers is that there is an investment component built into most types of permanent insurance so that money will grow in a “cash account”. Some of the many benefits of choosing cash value insurance over term insurance include:
- Lifelong financial protection
- Savings component that earns interest
- Provides the named insured with a living benefit
- Level premiums for a lifetime
- Tax-deferred cash value growth
- Guaranteed coverage for life if the insured is diagnosed with a medical issue
Understanding How Premiums Are Divided
When you pay for a term life insurance policy, whether it is a renewable or annual term, all of the premiums that you pay will go towards the coverage for the death benefit. The premiums are paid to cover the cost of pure insurance and the company fees associated with managing the policy. The benefit will remain level for the entire term and you have the option to reapply once your term is up if you qualify.
How are premiums used?
The way that premiums are used for a permanent cash value plan are very different. Instead of paying level premiums for a period of time to cover the cost of pure insurance, you will pay leveled premiums for a lifetime that will be divided up to pay for the following:
- pure insurance costs
- sales expenses
- insurance expenses
- cash account funding
What is the cash account interest rate?
Whatever is left over after paying for the cost of insurance and expenses is placed into the cash account where interest is guaranteed. The pace at which the cash account will grow depends entirely on the premium amount that you pay, the guaranteed interest and whether or not that interest goes up. This is especially true with the more modern Universal Life cash value plan as opposed to a Whole Life insurance plan.
What are the different types of permanent life insurance cash values?
Cash value is a great incentive for those who want life insurance and a savings component all-in-one. While it is an incentive, it is also one of the most confusing aspects of permanent life insurance that will scare people away from selecting the higher priced option.The confusion is not around the death benefit but instead how the cash accumulates when you are alive and what might happen if the policy cancels before death. There are two different types of cash value terms used by life insurance carriers in policy contracts:
- Guaranteed Cash Value
- Net Cash Value
Each term refers to a different type of accumulation structure that can affect the final policy value for your beneficiaries and how your money that is paid into the policy is used. Here is a breakdown of how each of the types of cash value accumulation term works:
Guaranteed Cash Value Structures
If you were to purchase either an ordinary whole life insurance policy or a universal life insurance policy, you would notice that the contract will include a minimum guaranteed interest rate that applies to the cash account. This is written into the contract so that the policyholder is protected no matter how the economy might be performing at the time.
- What happens when there are economic issues?
If the current interest rates in the financial sector change because of a natural disaster or a stock market crash, the policy will not be affected and it will continue to grow at a pace that you can predict. What is great about this structure is that your cash account interest rate can go up if there is a huge rate increase in the market, but the rate will never go down below the rate that is guaranteed. All of the money that grows in this account will grow tax-deferred.
- What happens if the economy performs better than expected?
The guaranteed rate is technically a worst-case scenario. These guarantees do not apply to variable permanent plans because they are invested in a large spread of different funds to offer more versatility to policyholders. This versatility comes with more risk, but it better for those who want to take the risk to watch their account value grow liberally.
Net Cash Value
The net cash value of a policy also called the net surrender cash value, is not the guaranteed interest rate that you will receive. It is the amount of money that you will receive if you decide that you do not want to keep your life insurance policy and you cancel the permanent life protection. You are entitled to the surrender value of your cash account because this is considered to be a living benefit.
The net cash value, or surrender value, of the policy, may be lower than you might expect even if you have had the policy for years. Here are some things you should know about surrender values before you give up the coverage that you have issued to protect your family financially for life:
- Fees and Other Expenses Will Be Deducted
Life insurance companies spend a significant amount of money to underwrite and then issue permanent life insurance policies. The reason that so much money is spent is because covering someone for a lifetime is a huge risk. They know the client will have a covered claim at some point after inception, but they do not know how long they will collect premiums. This is why applications for permanent coverage are put under a microscope.
Premiums paid for the policy after issuance will be used to cover pure insurance and the salaries, fees, and commissions paid to personnel and agents. Because of this, a large portion of the premiums that you pay in the first years of your policy will not go into the cash value. The expenses will be deducted from your cash account value when the policy is canceled. After the fees are subtracted the net surrender value is determined.
- Tax Implications of Surrendering a Cash Value Policy
You will receive a check for the net cash value of your canceled insurance, but many policyholders overlook the importance of learning the tax implications of surrendering life insurance before they submit their written cancelation request.
There are not tax penalties when the cash value is paid out in the form of a claim, but when the balance is paid out while the named insured is still living there can be.
The surrender value, after the fees and expenses have been deducted, will be considered taxable income in the year that the insurance policy was canceled. Luckily, the money that was paid into the policy as premiums will be subtracted to keep the taxable portion low.
When the tax season approaches, you will receive a 1099-R form from your insurer that will show the taxable portion of the disbursement so that there is no confusion on your part. It could be a large amount if you have had a policy for years and the interest rate for the cash account was high.
Now that you know the difference between the structures that exist for permanent life, you can make a more informed decision as you shop for coverage. If you are still interested in a cash value policy, make sure you compare premiums first and then companies. You can compare rates online by using an online rate comparison site and answering just a few basic underwriting questions. Be sure to be honest with the form, and you can instantly compare rates by just logging on to the Internet and selecting a policy type and limits. Start comparing life insurance rates now by entering your zip code in our FREE tool below!