A cash value life insurance policy is one that not only has a death benefit, but it also allows you to accumulate cash in an investment account.
A death benefit refers to the amount that is received by the beneficiaries after the insured person passes away. This is also known as the “face value” of the policy or the amount of life insurance coverage bought. A cash value is an added benefit that makes a part of your premium payment available to you while you are alive.
With a cash accumulation life insurance plan, the money you pay is essentially divided into 3 categories:
- Cost of insurance: Amount of money that will fund the death benefit
- Fees and overhead: Insurance firm’s fees and operating charges
- Cash value: The account that accumulates cash value as per policy
The different types of cash value life insurance policies include whole life insurance, universal life insurance, indeed life insurance and variable life insurance.
Benefits of a cash accumulation insurance plan
The cash value of this type of life insurance plan can be used for your benefit during your lifetime. Here is how it can benefit you:
1. Withdrawing money
With a permanent cash value life insurance policy, you can make a tax-free withdrawal. However, if the amount you withdraw is higher than the amount you have paid so far into the cash value part of the policy, then it will be taxed as income. Remember that withdrawing money reduces the death benefit received by your beneficiaries when you pass away.
2. Saving for retirement
Many people opt for a cash value insurance policy as a retirement plan, along with providing a death benefit to their beneficiaries. Some companies offer employees a life insurance policy as part of their retirement plan.
In this case, the amount an employer would contribute to the cash value part of the policy will be tax deductible. However, any increase in the cash value due to interest or investment gains will be tax deferred until the money is withdrawn from the policy.
In case your company does not offer a retirement plan or a life insurance option, a cash value insurance policy can still provide tax benefits of a qualified retirement plan. Insurance premiums are not tax deductible, but any increase in your cash value account due to investment gains will not be taxed until you withdraw the money after retirement. The tax value grows tax deferred and withdrawals may also remain tax-free unless you decide to go for tax-favored withdrawal provisions offered by cash value plans.
3. Surrendering the policy
If you decide to surrender the policy, you can get back the money that accumulated in the cash value portion with accrued interest. However, the insurance company may subtract some amount if you took any loans or had any unpaid premiums on the policy.
Look out for any additional surrender fee that you may have to pay upon cancellation of your policy. You may also be charged an income tax on the amount.
4. Taking a loan
A cash value insurance plan enables you to borrow up to the cash value of your policy. This amount includes the portion of the paid premium that was added to the cash value along with the interest accrued on that amount.
Like other loans, this loan has to be paid back into the account by a certain date. A major benefit of this feature is that it enables you to keep the tax-deferred status of the amount in your account.
The loan is not considered taxable income, according to the American Institute of CPAs. Moreover, when you pay back the amount, you will continue to earn interest on it along with the cash that keeps getting added to it from the premiums you keep paying.
5. Using cash value to pay for premiums
In case you are short on cash, you can use the cash value portion of your policy to pay your premiums. Make sure how this feature would work for your specific policy.
Be careful because there is also a risk of a lapse in your insurance policy if you withdraw the entire amount in your cash value account. This could end your life insurance coverage altogether.
A cash value life insurance plan offers flexibility. The cash value of your policy can grow tax-free by accruing interest. The amount can be accessed through loans and withdrawals without having to pay income tax on it.
To explore insurance policies using tax exempt strategies, click here.
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