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cash value life insurance good investment

Why cash value life insurance may be a good investment

Many insurance companies that market annuities for retirement income also promote permanent cash value life insurance as a potential source of income for retirement or other purposes. There are many arguments for and against this strategy. This article will cover the reasons life insurance may fit well into your overall financial and/or retirement income plan.

What is cash value life insurance?

Cash value life insurance allows policyholders to keep their insurance as long as they pay the premiums, even if that is for their lifetimes. This is different than term insurance, which is only good for a defined term, be it 10, 20 or 30 years from when it is purchased. The other major difference between the two types of insurance is that cash value insurance builds an account value that policyholders can access, while term insurance offers nothing more than the death benefit.

There are two basic types of cash value life insurance: whole and universal. Whole life insurance is meant to be owned for a person’s “whole life” and the policyholder pays the same level premium for as long as he or she owns the policy. It builds cash value from the reserves that insurers set aside to ensure they can pay a death benefit.

Universal life (UL) insurance is more flexible than whole life, but also has less of a guarantee. When you buy a universal life insurance policy, your premiums support the amount of coverage you elect to own, which is called the face amount. Each premium payment you make goes into the policy’s account value. From this account, the insurance company deducts its costs and expenses. The amount left over collects interest, which then becomes the cash value of your policy. You can vary the amount, timing and frequency of payments as long as the policy has enough cash value to cover expenses.

The case in favor of cash value life insurance

While the premiums on cash value life insurance are more expensive than on term policies, you receive more value.

Term policies expire after 10, 20 or 30 years, depending on the length of the term you purchased. Therefore, it’s possible and in some cases likely that you will outlive the policy. In fact, it’s estimated that only 2 percent to 5 percent of term policies ever pay a death benefit.

Another downside to term is that your health could prevent you from qualifying for another policy once the original term expires.

On the other hand, cash value life insurance will last as long as you pay premiums and it has cash value, until you pass away. Even if your health deteriorates, you can’t lose the coverage.

Provided a cash value insurance policy remains, by IRS definition, an insurance policy and does not become an investment vehicle, it offers the same tax-deferred growth as annuities and qualified retirement plans, meaning you do not have to pay taxes on the policy’s interest growth each year.

Life insurance also has special tax treatment that allows you under some circumstances to loan yourself part of your cash value without owing taxes on the proceeds. Depending on the provisions of your contract, you can often take as long as you wish to pay back the policy loan, or you can choose not to repay the loan and accept a lower death benefit. If you choose to repay the loan, you will often receive a more favorable interest rate than you would through traditional lenders, and the loaned funds will continue to earn interest as if they were never withdrawn.

Also, because life insurance withdrawals are not taxable, they don’t impact the formula the IRS uses to determine whether to tax your Social Security benefits.

At the same time, there are no IRS contribution limits on life insurance so it’s potentially a way to save large sums on a tax advantaged basis. In addition, you don’t have to wait until you’re 59 1/2 to access the funds in your life insurance policy like you do for annuities and 401(k)s.

Life insurance is also fairly liquid. While most annuity contracts only allow you to withdraw 10 percent of the account value with a surrender charge, many life insurance policies allow you to withdraw up to 90 percent of the cash value.

 

Lastly, most types of cash value life insurance will not lose their value based solely on the performance of the stock market or other economic factor. While there are variable UL policies in which you can invest your premium, most UL policies and whole life insurance pay either a fixed rate of interest or provide a guarantee minimum with the insurance company taking on the investment risk.

 

While cash value life insurance is not suitable for all, it has the potential to provide lifelong insurance coverage and cash value that you the policyholder can access for a variety of uses.