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What is 'Cash-Value Life Insurance' Cash-value life insurance is a type of life insurance policy that pays out upon the policyholder's death, and also accumulates value during the policyholder's lifetime. The policyholder can use the cash value as a tax-sheltered investment (the interest and earnings on the policy are not taxable), as a fund from which to borrow and as a means to pay policy premiums later in life, or they can pass it on to their heirs. Cash-value life insurance is a type of life insurance policy that pays out upon the policyholder's death, and also accumulates value during the policyholder's lifetime. The policyholder can use the cash value as a tax-sheltered investment (the interest and earnings on the policy are not taxable), as a fund from which to borrow and as a means to pay policy premiums later in life, or they can pass it on to their heirs BREAKING DOWN 'Cash-Value Life Insurance' Whole life, variable life and universal life are all types of cash-value life insurance. Cash-value insurance is also known as permanent life insurance because it provides coverage for the policyholder's entire life. The other major category of life insurance is called term insurance, because it is generally in force only for a period of 10 to 30 years or until the policyholder cancels it. Cash-value insurance has higher premiums than term insurance because part of the premium pays for the death benefit coverage and part of it goes toward the policy's cash value. How Cash-Value Life Insurance Works Cash-value life insurance is designed as a permanent form of life insurance that includes a death benefit component and a savings component. Most cash-value life insurance policies require a fixed level premium payment, a portion of which is applied to insurance costs with the balance deposited into a cash-value account. The cash-value account earns a modest rate of interest which is allowed to accumulate tax-free. Over time, the cash-value account grows, which reduces the mortality risk of the life insurer. That is because, upon the death of the insured, the insurer is only obligated to pay the death benefit, not the cash value, which it retains. The decreasing mortality risk is also the reason why the insurer is able to guarantee a fixed, level premium for the life of the insured. Cash-Value as a Living Benefit Owners of a cash-value life insurance policy can benefit from savings that accumulate in the cash-value account. Cash-value savings can be accessed in a number of ways. With some types of policies, the cash value can be withdrawn. Withdrawals are tax-free to the extent they don’t exceed the total amount of premiums deposited into the policy. However, withdrawals can have the effect of decreasing the death benefit amount. Most cash-value policies allow for loans to be taken from the cash-value. Loans will also decrease the death benefit amount. Although there is no requirement for the loans to be repaid, the death benefit is reduced by the loan amount. Loans do accrue interest, which can reduce both the cash-value balance and the death benefit further. Cash-value can also be used to pay the policy premiums. If there is sufficient cash-value, a policyholder can stop paying for premiums out-of-pocket for the life of the policy.
LIFE INSURANCE What is 'Life Insurance' Life insurance is a protection against financial loss that would result from the premature death of an insured. The named beneficiary receives the proceeds and is thereby safeguarded from the financial impact of the death of the insured. The death benefit is paid by a life insurer in consideration for premium payments made by the insured. BREAKING DOWN 'Life Insurance' The goal of life insurance is to provide a measure of financial security for your family after you die. So, before purchasing a life insurance policy, consider your financial situation and the standard of living you want to maintain for your dependents or survivors. For example, who will be responsible for your funeral costs and final medical bills? Would your family have to relocate? Will there be adequate funds for future or ongoing expenses such as daycare, mortgage payments and college? It is prudent to re-evaluate your life insurance policies annually or when you experience a major life event like marriage, divorce, the birth or adoption of a child, or purchase of a major item such as a house or business. How Life Insurance Works Life insurance is a contract between an individual with an insurable interest and a life insurance company to transfer the financial risk of a premature death to the insurer in exchange for a specified amount of premium. The three main components of the life insurance contract are a death benefit, a premium payment and, in the case of permanent life insurance, a cash value account. Death Benefit: The death benefit is the amount of money the insured’s beneficiaries will receive from the insurer upon the death of the insured. Although the death benefit amount is determined by the insured, the insurer must determine whether there is an insurable interest and whether the insured can qualify for the coverage based on its underwriting requirements. Premium Payment: Using actuarially based statistics, the insurer determines the amount of premium it needs to cover mortality costs. Factors such as the insured’s age, personal and family medical history, and lifestyle are the main risk determinants. As long as the insured pays the premium as agreed, the insurer remains obligated to pay the death benefit. For term policies, the premium amount includes the cost of insurance. For permanent policies, the premium amount includes the cost of insurance plus an amount that is deposited to a cash value account. Cash Value: Permanent life insurance includes a cash value component which serves two purposes. It is a savings account that allows the insured to accumulate capital that can become a living benefit. The capital accumulates on a tax-deferred basis and can be used for any purpose while the insured is alive. It is also used by the insurer to mitigate its risk. As the cash value accumulates, the amount the insurer is at risk for the entire death benefit decreases, which is how it is able to charge a fixed, level premium.