Cash value life insurance can be used as a way to accumulate cash that could be used for specific purposes in the future, such as paying off your mortgage early, funding your child's college education, or funding your retirement. That's because cash value policies have "living benefits" as well as a death benefit. The cash that accumulates is available to you for emergencies and opportunities during your lifetime. This cash accumulation earns a modest return.
Let's take a look at the financial objectives of cash-value insurance:
- Your need to save. Most of us plan on being around a long time, so accumulating cash makes sense.
- Your desire to avoid taxes. Your savings are tax-deferred, which means you pay no tax until you withdraw your savings. No taxes are due until you pull out more than you put in. If you borrow your funds, you may never have to pay taxes. And, as with all life insurance, the proceeds payable at your death are income-tax free.
- Your fears that there won't be enough savings to take care of your heirs. If you die before you have time to save enough money, the insurance company may provide your heirs with a substantial death benefit.
So when it comes to cash value life insurance, make sure you understand what it is, how it works, and whether or not it is the best option for you. Remember, your primary purpose for buying life insurance is to create an immediate estate for your heirs in the event you die prematurely. Your number one priority is making sure the death benefit is substantial enough to cover the needs and desires of those you leave behind.
If you do decide to borrow against your life insurance policy, it is important to understand how that transaction works and the possible risks to your policy and finances:
- It's a loan, and it accrues interest. You can typically borrow up to the accumulated cash value on your permanent life insurance policy. However, if you let unpaid interest accumulate or have it paid out of the life insurance dividends, the unpaid interest could accrue as income and be subject to taxation by the IRS. The loan itself will also increase by the amount of the unpaid interest. If your dividends aren't enough to cover the premium plus the loan and interest payments, you may have to pay more in life insurance premiums.
- It could reduce the benefits to your beneficiaries. If you die with the loan outstanding, the amount will be deducted from your death benefit, which could leave your loved ones without needed funds.
Employer-Sponsored Group Whole and Universal Life Policies
You and your spouse may have the opportunity to purchase permanent (cash value) life insurance as an employee benefit. Before you decide to purchase, consider the following:
- Will you need life insurance when you retire? If you think that you won't have enough income or income-producing assets for your spouse or dependants in the event of your death, or you still have money to save after fully funding your retirement plans, then permanent life insurance may be right for you.
- If you are considering permanent insurance and you are a non-smoker and in good health, compare the group universal life or group whole life policy with a similar policy you could purchase on your own. Insurability is not an issue for you. You may be able to find a policy that offers you a larger death benefit and greater potential cash value for a smaller premium.
SUGGESTION: Your company may be large enough that the insurance company designed the policy with lower expenses. Make sure you do an accurate comparison with an individual policy that you may be considering.
- The dollar amount you can afford will usually buy a relatively low death benefit. The cost of universal life insurance with a specified face amount under $100,000 is relatively high compared with the same policy issued with larger death benefits. The contract charges eat up much of the premium and the actual return on your cash value may be negligible.
SUGGESTION: If you're not putting the maximum contribution into your retirement plans, consider opting for term insurance. Fund your retirement plans first.
Who should consider employer-sponsored products?
If you've been rated by an insurance company and need a cash-value policy, or you simply don't want to be bothered with many underwriting requirements, you may have a better chance of securing life insurance with employer-sponsored group whole- and universal life.