Cash value, also known as cash surrender value or policyholder equity, is a feature found in certain types of permanent life insurance policies, such as whole life insurance and universal life insurance. It represents the savings component of the policy and offers several benefits:
1. Accumulation of Funds: A portion of the premiums you pay for permanent life insurance goes into a cash value account within the policy. This cash value grows over time, typically on a tax-deferred basis, which means you don’t pay taxes on the growth until you withdraw the funds.
2. Access to Funds: Policyholders can access the cash value in several ways:
- Withdrawals: You can withdraw money from the cash value account, often up to the amount you’ve paid in premiums, without incurring income tax. However, any withdrawals beyond what you’ve paid in premiums may be subject to income tax.
- Policy Loans: Many permanent life insurance policies allow you to take out loans against the cash value. These loans are typically not taxable, and you don’t have to repay them, although any unpaid loan balance will reduce the death benefit paid to your beneficiaries.
- Surrender: You can surrender the policy and receive the cash value, minus any surrender charges or fees imposed by the insurance company. Surrendering the policy will terminate the coverage.
3. Financial Flexibility: The cash value component offers financial flexibility. It can be used for various purposes, including:
- Supplementing retirement income.
- Paying for unexpected expenses or emergencies.
- Funding education expenses.
- Acting as a source of funds for investments or business opportunities.
4. Potential for Growth: The cash value in permanent life insurance policies often has the potential to grow over time, although the growth rate is usually lower compared to other investment options like stocks or mutual funds. However, it comes with lower risk as well.
5. Estate Planning: Cash value can play a role in estate planning. It can be used to provide a tax-efficient way to transfer wealth to heirs or cover estate taxes.
How Cash Value Works:
- Premium Allocation: When you pay premiums for your permanent life insurance policy, a portion of these premiums is allocated to the cash value account after deducting fees and the cost of insurance coverage.
- Investment Component: The insurance company typically invests the cash value in conservative, interest-bearing assets like bonds or money market funds. Some policies allow policyholders to have a say in how the cash value is invested.
- Growth and Accumulation: Over time, the cash value grows based on the interest or investment returns credited by the insurance company. This growth is often on a tax-deferred basis, meaning you won’t pay taxes on the gains until you access the cash value.
- Access and Use: You can access the cash value through withdrawals, policy loans, or policy surrender, depending on your needs and goals.
- Impact on Death Benefit: Keep in mind that accessing the cash value through loans or withdrawals may reduce the death benefit paid to your beneficiaries. If loans are not repaid, they will be subtracted from the death benefit when you pass away.
It’s essential to carefully consider the terms and conditions of your specific life insurance policy and consult with a financial advisor to determine how the cash value component can best serve your financial goals and needs.