How Much is Your Life Insurance Policy Worth?

Updated

There are a couple of key reasons why people buy life insurance. The first reason is to provide financial protection for their family. If they pass away while their income is still needed, life insurance will provide a replacement. This protection can also pay off a mortgage, cover the cost of a college education, and help meet other financial goals.

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The second important aim for many people shopping for life insurance is investing in a policy that accumulates cash value. This article will focus on the cash value element of a life insurance policy: what it is, how it accumulates over time, how you access it, and more. 

What is The Cash Value of a Life Insurance Policy?

The cash value of a life insurance policy is the amount of money that has accumulated over time “inside the policy.” 

Every time you make a premium payment on your permanent life insurance policy, portions of that payment go toward the death benefit amount, the policy’s fees, and the cash savings component. 

As more premium payments are made over time, interest is credited to the policy's cash value. This accumulated cash value is then available to the policy owner after a period of time specified by the policy.

Does Cash Value Differ in Term or Whole Life Insurance Policies?

To fully understand cash value, it’s important to talk about the two main categories of life insurance: term life insurance and whole life insurance.

Term life insurance is where the insured pays premiums for a set “term” (usually between 10 and 30 years). If the insured dies during that term, their beneficiary receives a death benefit payout. However, if the insured is still living when the term expires, coverage ends and no death benefit is paid out. Term life insurance does not accumulate cash value. 

Whole life insurance is a type of permanent life insurance, which means it has no set expiration date. A death benefit is paid out to the beneficiary when the insured dies, as long as premium payments are up to date and the policy is still in force. Whole life insurance accumulates cash value as you make payments.

Unlike whole life insurance, term life insurance doesn’t accumulate cash value. All of the premiums paid for the term policy go towards the cost of the insurance protection and the fees the insurance company charges.

How Does Cash Value Change Over Time?

Your policy’s cash value grows every time you make a premium payment. A portion of the premium in a whole life policy is allocated to the cash value. With each additional premium payment, the cash value grows, much like every deposit into a savings account causes the account to grow.

For example, let’s say that you were issued a whole life insurance policy with a monthly premium of $100. Of that $100 premium, $50 goes toward insurance company charges, and the other $50 goes into your policy’s cash value. 

Along with the growth occurring every time you make a premium payment, your policy’s cash value will grow through two other means: interest and dividends (if the insurance company is a mutual company). 

Let’s look at each of these cash value builders.

Interest is paid at a minimum guaranteed rate specified by the policy. Most insurance companies guarantee that interest is credited to the policy’s cash value at a rate of no less than 3% to 5%. This interest rate is typically higher than that paid by a bank or credit union.

Dividends are paid at the insurance company's discretion and are payments of a portion of the company’s profits to its policy holders. These dividends are either added to the policy’s cash value, or the policyowner can apply them to future premium payments.

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How Do You Access the Cash Value of Your Policy? 

There are several ways that a policy owner can access their policy's cash value: either by borrowing from the cash value, withdrawing money from the cash value, or through a surrender (cancellation) of the policy. 

Cash value withdrawals are similar to withdrawing money from your savings account at your bank or credit union. The money you withdraw will no longer be in your cash value account to receive interest. You can do with this money whatever you please, and it doesn’t need to be repaid to the life insurance company. In addition, cash value amounts you withdrew from your policy do not need to be repaid if you die while the policy is in force.

Policy loans are precisely what the name implies. After you’ve withdrawn the maximum amount specified in your policy based on its age, you can initiate policy loans to get cash. In effect, the insurance company is loaning you money from your death benefit. 

Outstanding policy loan balances are subtracted from the payout made to your beneficiaries. This means a $100,000 whole life policy with an outstanding loan balance of $10,000 would pay your beneficiary a death benefit of $90,000.

The interest credited to your cash value account by the insurance company is used to partially or fully pay your interest for the loan.

Surrender or cancellation is when you decide to discontinue your premium payments on the policy, and you want to withdraw the full cash value of your account. “Surrender charges” will be subtracted from the total cash value accumulated. These charges decrease the longer you have your policy active.

When you surrender your policy, you nullify the death benefit payout because the policy is no longer in force.

How Do You Figure Out the Cash Value of a Life Insurance Policy?

There are a couple of different ways to figure out the cash value of a life insurance policy:

Call the insurance company directly. The agent who sold you the whole life policy can make that call for you (if they’re still licensed and in good standing with the insurance company), or you can make the call yourself, which is preferable for your financial safety

Read the policy statement that you receive annually. That policy statement will provide you with all of the metrics of your policy: cash value, surrender value, outstanding loan balance, death benefit, and more. These numbers change every month, so you’ll only have a semi-accurate snapshot of the policy the day your policy statement arrives.

What Can You Do With the Cash Value of Your Life Insurance Policy?

You can do anything you’d like with the cash value of your policy. After all, you are the policy owner and everything associated with it, including its cash value.

One thing you can do is just leave it in the policy and let it accumulate more value until you need it.

Other than that, you can withdraw from the policy for practical items, like paying off a mortgage, funding your children’s or grandchildren’s education, taking a long-awaited vacation, or supplementing your other savings, retirement plans, and income. 

Buy Term and Invest the Difference?

When helping their clients find a life insurance policy, many financial advisors counsel their clients not to buy whole life insurance if they want to use it to build cash value. Instead, they suggest purchasing term life insurance (which is substantially less expensive) and investing the money left over in something with a higher rate of return. This includes investments like stocks, bonds, mutual funds, or even real estate.

An annual rate of return on a mutual fund, for example, can provide a substantially higher rate of return than the interest rate guaranteed on a whole life insurance policy. 

However, such investments can also lose value, depending on fluctuations in the market. A whole life policy guarantees that you’ll be paid a minimum rate of return on your cash value.

Getting the Best Value Out of Life Insurance

Many financial advisors will tell you that term life insurance is sufficient for a young family. Others, however, will tell you that term insurance is like renting; you’ll have nothing to show for it at the end of the term. 

If you have a family and a life insurance policy with a $250,000 death benefit, your beneficiaries won’t care if it was a term life insurance policy or a whole life insurance policy. The fact that they received the life insurance policy payout is what matters.

If you decide that a policy with a cash value aspect is a better choice for you, compare several top-rated insurance companies’ policies and compare their guaranteed interest rates, as well as dividends.

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