Cash Value Life Insurance: Should You Buy It? – Motley Fool

What is cash value life insurance?

There are two primary types of life insurance: term and permanent. As the name suggests, a “term” policy only lasts for a specified time. As long as the policyholder keeps up with the premiums, permanent life insurance is meant to be lifelong. Cash value life insurance is a type of permanent policy. In addition to the face value of the life insurance (the amount the policyholder is insured for), it builds cash value. A portion of each premium payment is put aside, and the cash that accrues earns interest, and may be available to withdraw or borrow against.

How cash value life insurance works

Cash value life insurance offers two features in a single policy:

Death benefit. This is the amount paid out to a policyholder’s beneficiaries after they die. It is sometimes referred to as “face value.” The face value of life insurance is how much someone shops for once they’ve answered the question, “How much life insurance do you need?” For example, if a person with a young family is concerned about how their family would get by after their death, they may look for enough coverage to pay things like the remaining mortgage, their kids’ education, and other everyday expenses. Adding up the expected cost gives a rough idea of how much a death benefit should be.Cash value. Not all permanent policies offer cash value, but those that do typically give the policyholder access to those funds while they’re still alive. One benefit is that the cash value portion of a policy builds tax-deferred interest. The amount of interest depends on the type of policy.

Types of cash value life insurance

Each of these policy types may build cash in the life insurance policy:

Whole life insurance

Whole life is the most common type of permanent policy. In essence, it offers a death benefit along with a savings account. Each insurance company sets its own interest rate or dividend it pays on whole life insurance cash value.

Universal life insurance

Universal life insurance is a bit more flexible. As long as the policyholder passes a medical exam, they may be able to increase the death benefit even after they’ve held the policy for some time. In other words, the benefit isn’t locked in. The cash value account portion of the policy usually earns interest around the same rate as a money market account. Once enough cash has accumulated, the policyholder can use some of those funds to pay premiums (or part of the premiums).

While using the life insurance net cash value to pay premiums sounds great, it is not without risk. Once the cash value is used up, the policy runs the risk of lapsing.

Variable universal life insurance

Another type of permanent life insurance is variable universal. In addition to a death benefit, this policy takes the money that accrues as cash and invests it in stocks, bonds, and money market mutual funds. If the market is up, the cash can grow rapidly. When the market drops, the policyholder runs the risk of losing both the cash and part of the death benefit. Some, but not all, companies guarantee that the death benefit will never drop below a specific amount.

Indexed universal life insurance

There is also a death benefit and savings component with an indexed universal life policy. The difference is that the cash value in the account earns interest based on how a specific stock market is doing. The policyholder has no say in which stock market is used, although they do know when they purchase an indexed universal life insurance policy which market the company plans to use. Most policies come with an interest rate guarantee, meaning the interest rate can’t fall below that benchmark no matter what happens in the market.

Does term life have a cash value?

Term life does not build cash value. However, the cost of a permanent life policy is typically five to seven times more than the cost of a term life policy.

Pros and cons of cash value life insurance

As with everything, there are pros and cons with cash value life insurance.