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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 Happens To Cash Value In A Life Insurance Policy At Death
Quick Answer
In addition to providing a death benefit, cash value life insurance builds up cash value you can draw from now. But unless you withdraw, borrow or otherwise use the cash value, it typically goes to the insurance companynot your beneficiariesafter your death.
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Life insurance offers a way to provide your loved ones with financial security after your death. Some types of life insurance come with an extra benefit: cash value that you can build on and draw from during your lifetime.
There’s a catch, though. If you don’t use the cash value from your life insurance before you die, the money reverts to the life insurance carrier. Due to this risk, you should carefully weigh the pros and cons of a cash value life insurance policy and how you might use it before buying one.
How Does Whole Life Insurance Work
Your premium payments remain the same over the life of the policy, and a portion of it goes toward the insurance, which includes any fees and death benefit coverage.
A small amount from each payment is also set aside to build up your predetermined, guaranteed cash value.
With this policy, you can borrow against the cash value if needed. When you pass away, an income-tax free death benefit is paid to your beneficiaries. Keep in mind that borrowing against the cash value will reduce the death benefit paid to your beneficiaries, though.
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Is There An Alternative To Cashing Out A Life Insurance Policy
Many people consider cashing in their life insurance policy in order to access the cash value through a loan or to get a cash payment. While this can give you a modest sum of money, another option to consider is selling your life insurance via a life settlement, due to the fact that a life settlement can typically net four to eight times its cash surrender value. Due to the increased cash payout, life settlements are a wonderful option for dealing with an unwanted or burdensome life insurance policy.
Selling your life insurance policy via a life settlement allows you to treat your life insurance policy like a car, house, or any asset that you own and sell it to a life settlement company in exchange for cash. One major benefit of Life Settlements is that any type of policy is eligibleeven term life insurance . The way Life Settlements works is that the investor gives you a cash payout, assumes the premiums, and then receives the death benefit. Life settlements can give you the cash you need to achieve your financial goals.
To learn more about life settlements and see if you might qualify, visit our life settlement calculator. I am also happy to answer any and all questions about these life-transforming transactions.
Leo LaGrotte
How Do I Calculate The Cash Surrender Value Amount Of An Insurance Policy
Your whole life cash surrender value is the guaranteed case value shown on your policy plus the value of any dividends accumulated in the policy.
Your universal life cash surrender value is the current case value of your policy less any surrender charges. And, if youve had the policy for 10-15 years, the surrender fees typically go away.
But in either case, you can contact your life insurance company for your current surrender value. Also, if your cash surrender value is higher than the amount youve paid into your policy, you will likely have to pay taxes on the difference.
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What Is 7702 Life Insurance
Cash value life insurance policies are sometimes referred to as 7702 life insurance. This just means that theyre compliant with section 7702 of tax regulation. Life insurance policies have a variety of tax benefits, such as the death benefit paid to beneficiaries being free of income tax. Section 7702 was created to limit what could be considered as a life insurance policy and make sure other investments werent reaping the same tax benefits.
What Is Whole Life Insurance Cash Value
Whole life insurance plans have two parts: the death benefit that is paid out to your beneficiaries when you pass away and the cash value. That cash value is a savings account that takes funds from a portion of your premiums. This is often why permanent life insurance plans tend to be more expensive than term life. You are paying to fund your cash value on top of the main death benefit.
Whole life insurance cash value increases at a set schedule and by a fixed rate, usually at 2%. It is not tied to direct investments or indexes the way some universal life plans are.
Ed Slott a renowned tax expert on tax benefits of IUL policies
Indexed Universal Life Insurance Policy is a Great Tax-Free Retirement Savings Plan
- Cash value growth tied to the performance of S& P 500 Index, with average annual return of 10.1% in the past 30 years
- Tax-free cash value growth and withdrawals
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How Does Cash Value Life Insurance Work
When you make premium payments on a cash value life insurance policy , part of your payment is allocated to the policy’s cash value savings component, which accrues interest over time. Whole life policies grow their cash value via a fixed interest rate, while universal life policies grow their cash value at a rate more dependent on the market .
Depending on the type of life insurance policy you have, your cash value can be used in different ways. If you have whole life and your cash value grows to equal your death benefit amount, your insurer will automatically terminate your policy and pay out the death benefit to you. If you have universal life, your cash value has the potential to result in a zero-cost policy that means all premiums are paid from the built-up cash value. Both types of policies have cash value that can be used as a life insurance loan once it grows to a certain amount.
Note: The cash value insurance feature is generally designed to benefit you while you’re still alive by providing you with a loan option and a way to potentially decrease your premium payments. Your cash value will not affect your death benefit amount unless your policy specifically allows for the cash surrender value to be added to your death benefit .
Will I Be Taxed On The Growth Of The Cash Value Of My Life Insurance What If My Policy Pays Dividends
One of the advantages of cash value life insurance is that any earnings in the cash value do not incur a current tax liability. In general, any earnings in the cash value are allowed to grow on a tax-deferred basis until one of the following events occurs:
- The policy is surrendered
- The policy is transferred for value
- The policy ceases to meet the IRS definition of a life insurance contract
Typically, there is no tax liability until one of these events occurs because of the substantial limitations and restrictions on receiving distributions from the cash value. Generally, if you receive the proceeds under a life insurance contract as a beneficiary due to the death of the insured person, the benefits are not includable in gross income and do not have to be reported any interest you receive is taxable and you should report it just like any other interest received.
Policy withdrawals are not subject to taxation up to the amount paid into the policy. Policy loans and/or withdrawals will be taxable to the extent of gain if the policy is a modified endowment contract. Policy loans and/or withdrawals also reduce the cash surrender value and policy death benefit and increase the chance that a policy will lapse. Taking a policy loan could have adverse tax consequences if the policy terminates before the insured’s death.
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Disadvantages Of Permanent Life Insurance
The biggest disadvantage of permanent life insurance is the cost.
Permanent life insurance is expensive because it covers you for your whole life. Most people dont need this much coverage. Term life insurance is cheaper because it covers you for a specific period of time and tends to work better for most people.
If you start with a term policy, you can convert it to permanent life insurance later on. But you cant convert a permanent policy to term life. This can be a problem if you start with a permanent life insurance policy and realize later that it isnt right for you.
If you cant make your premium payments, you could lose coverage. This means youd have to buy a new policy later on likely at an even higher price if you want to continue coverage.
What Happens When You Surrender Your Life Policy
Another important thing to note is when you surrender your life policy, you may get the cash you need when you need it, but youll no longer have the death benefit, which is the amount your beneficiaries would receive upon your death.
Trying to replace that death benefit later by getting coverage again could be more expensive down the road. And health changes could mean you wouldnt qualify for a new policy, so be sure to talk with your insurance agent about the consequences of surrendering your life insurance policy.
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Cash Value Is Not Paid To Beneficiaries
When you pass away, cash value typically reverts to the life insurance company. Your beneficiaries receive the policys death benefit amount, minus any loans and withdrawals of cash value you made. That said, there are some policies that will pay out the death benefit plus cash value to beneficiaries, but be prepared to pay substantially more for this feature.
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Withdraw Money Or Borrow Against It
When you pay your premium on a universal life insurance policy, a portion of each payment goes toward paying for the death benefit. Another portion also goes to building up the policy’s cash value. Over time, after money has accumulated, you may be able to withdraw or borrow against the cash value of the policy ¹. The rules on how and when you can do this vary by insurance company and policy. However, it’s important to know that this may reduce your death benefit, create a tax implication or even cause your policy to lapse.
How Do I Access The Cash In Cash Value Life Insurance
Jack didnt have to wait long for those magic beans to turn into a huge beanstalk. But what is the cash value of a life insurance policyand are you willing to wait 1015 years for some decent cash value? Because thats how long itll take.
Lets say you can wait 1015 years to build up your cash value. How can you take it out? Well, here are your choices, depending on whether youve got whole life or universal/variable life insurance . . .
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How Do You Get Money Out Of Your Whole Life Insurance Cash Value
There are several ways to get access to your whole life insurance cash value. A few main methods are:
- Loans: You can take out a loan against the cash value. This is typical of most loans in that you have to pay interest on the loan. Its typical to see 8 to 10 percent on loans against a cash value on a whole life policy. You must consider this option very carefully, as the interest rates can deplete the cash value faster. Also, if you do not pay the loan back, the amount you took out comes out of the death benefit. A positive is that there are no income taxes on loans as long as the policy is still in effect.
- Surrendering the policy: A more drastic way to access the cash value is to surrender the policy. You receive a cash surrender value, which is usually a portion of the cash value minus surrender charges. You have to pay income taxes on the money using this method, however.
- Selling the policy: Another option is to sell your policy to individuals or investment companies. They will take on ownership and pay premiums going forward. In return, you get a cash amount that is usually more than the surrender value and less than the death benefit.
Its important to note that withdrawals are not allowed on whole life policies.
Another way that you may be able to access cash in a whole life policy is that mutual whole life insurance companies pay dividends to their policyholders. You can elect to receive these as tax-free cash.
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What Is Cash Value Life Insurance
Cash value is a savings component typically included in permanent life insurance policies. Depending on your particular policy, the cash value can grow at a fixed or variable interest rate over time. You can borrow against your policy’s cash value in the form of a life insurance loan. If you have universal life insurance, cash value may also be used to adjust your premium or death benefit amounts.
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Strategy : Make A Withdrawal
If youre low on funds or simply want to make a large purchase, you have the option to withdraw some or all of your cash value. Depending on your policy and the size of your cash value, such a withdrawal could chip away at your death benefit or even wipe it out altogether.
While some policies are reduced on a dollar-for-dollar basis with each withdrawal, others actually reduce the death benefit by an amount greater than what you withdraw. Be sure to discuss this tactic with your insurance agent before you make any sudden moves.
How To Access The Cash Value In Your Life Insurance Policy
Premiums for cash value life insurance can be incredibly expensive, so its important to understand all the ways you can take money out of your life insurance policy. Whether you want to get rid of your coverage and cash out your life insurance or simply take out a loan, theres a variety of ways to take advantage of your policys cash value.
Even if you no longer want coverage, make sure not to let your policy lapse at any point. When a policy lapses, you lose the death benefit as well as any cash value you could have been paid.
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What Is Participating Life Insurance
Its lifelong coverage that pays whomever you choose a tax-free payment when you die. Your policy is guaranteed to grow in cash value as long as you pay your premiums. Cash value is the value of the insurance policy that you can access as cash. Your insurance payout is reduced when you access your cash value.
Your payments are pooled in a separate account called the participating account with other policyowners. The funds are professionally managed and may provide you with a dividend.
Reduction Of Benefits And Charges
In the early years of a policy, life insurance companies can deduct fees upon cash surrender. Depending on the type of policy, the cash value can be available to the policyholder during their lifetime. It is important to note that surrendering a portion of the cash value reduces the death benefit.
Depending on the age of the annuity, charges may apply to partial and full surrenders. Taxes are deferred until surrender, at which point an additional premature withdrawal penalty may apply depending on the age of the annuitant.
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When Do Cash Contributions Trigger A Modified Endowment Contract
Adding large lump sums of money to your policy can trigger your life insurance to be reclassified as a modified endowment contract by the Different rules apply to your tax liability under this classification.3 Other contract changes can also trigger the modified endowment contract status. Consult a financial advisor or tax professional before making changes to your cash contributions.