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How Do Cash Value Life Insurance Policies Work?

If you're considering buying a life insurance policy, you may have heard the term "cash value" and wondered if you should be concerned with it. Whether you need cash value life insurance is up to you. Below, we outline exactly how cash value life insurance policies work, and what you should expect if you choose this option.


cash value life insurance policies work

What is a cash value life insurance policy?

Cash value life insurance, also called "permanent life insurance," is available in a wide variety of options. Whole life, variable life, universal life, and variable universal life are all examples of cash value / permanent life insurance policies. The basic difference between all of these types of cash value policies is how the value of the policy is invested.


All cash value life insurance policies operate on the same basic premise: Your premium payments are allotted into three different payments. One portion pays the actual insurance benefit cost; another portion pays the insurance company; and a third portion is put into cash value. Read also: Who Needs Life Insurance?


Unlike term life insurance, cash value policy has a level premium amount that is particularly large at the beginning of the policy, when the policyholder is still young and in good health. This excess amount of money paid in is invested into a cash value account, which is designed to offset the costs of insuring yourself as you get older and your premiums would naturally increase.


In the early years of your policy, the largest percentage of your payments will go to this cash value fund. Every year, more of the money will go into insuring you and less will go into the cash value fund. This is because the cost of insuring you every year is going up, so a larger percentage of your money paid in is being used for insurance costs.


If you choose to cash in your policy before death, the cash value of this account, as well as any accumulated interest, is returned to you.


Do keep in mind that in order for your beneficiaries to receive the cash value of your account as well as the stated amount, you may need to sign some extra paperwork. Examine your policy carefully and make sure you select this option if you wish for your family to receive your cash value amount. Read also: What Is Life Insurance and Why Do I Need It?


Getting cash value out of your policy

The main reason people choose cash value life insurance policies is for help with retirement. This, along with retirement plans and social security, can help provide a safe nest for the later years.


Do keep in mind, however, that any cash you take out of your policy and do not pay back will be removed from your death benefits. In other words, it is your money to borrow, but if you don't return it to the policy your family will be minus that amount in the event of your death. You will also have to pay taxes on the money. The most common way for people to access the cash value in their account is by borrowing it out, although you can also make a direct withdrawal.


All cash value is tax-deferred until it is withdrawn.

The main reason for a cash value life insurance policy is to make it easier to continue your policy throughout your entire lifetime, without suffering huge payments as your health declines. It also helps to know that you have a cushion of cash value that you can borrow against in an emergency. Read also: College Student Life Insurance Policies: The Basics.


But consider cashing out your life insurance policy only as a last resort. With taxes and interest piling up, you'll be much better off financially in the long run if you can leave it there to do what it's meant to do: care for you through the length of your life and assist your beneficiaries thereafter.


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