How does cash value work in a Life Insurance policy?

How does cash value work?

I have learned that cash value in an insurance policy differs from putting money in a savings account, where you immediately watch your money grow as you deposit it. No, sad to say, that is not how cash value works.

Certain types of permanent life insurance, like whole life or universal life, allow you to build cash value. This part of your life insurance policy is like, and I repeat "like," a savings account attached to your policy.

Here's how cash value works in a whole life insurance policy:

1. Premium Payments: When you pay the premiums for your whole life insurance policy, a portion of the money covers the cost of insurance, administrative expenses, and other fees. The remaining portion goes to the cash value.

2. Guaranteed Interest: The cash value in a whole life policy accumulates at a guaranteed, fixed interest rate declared by the insurance company. This rate is set at the time of policy issuance and is often higher than the interest rates offered by savings accounts or other conservative investments. The guarantee provides policyholders with a steady and predictable cash value growth.

3. Growth Tax-Deferred: This means that the cash value in a whole-life policy can grow without you having to pay taxes immediately as long as the funds remain within the policy. Tax deferral can be advantageous for individuals looking to build wealth over time.

4. Dividends (for Participating Policies): Some whole life insurance policies are "participating," meaning policyholders may receive dividends. Dividends are a part of the insurance company's money, but they're not promised to be the same every time. Policyholders have options with these dividends: they can get them as cash, use them to buy more coverage, lower their premiums, or let them add to the cash value of the policy.

5. Loan Option: Policyholders can take loans against the policy's cash value. These loans gain interest and must be repaid from future premiums or death benefit payouts. If you don't pay back the loan, the amount of money paid to your designated beneficiary could be less than the death benefit.

6. Surrender Value: If the policy is surrendered (cancelled) before the insured person's death, the policyholder is entitled to the surrender value, which is the accumulated cash minus any surrender charges imposed by the insurance company. Surrender charges are typically higher in the policy's early years and decrease over time.

Here's how cash value accumulates:

Cash value builds up in your permanent life insurance policy because your premiums are split into three parts:

• Some of your premium pays for the death benefit
• Some cover the insurance company's expenses and profits
• and the rest adds to the cash value of your policy

So, in addition to your beneficiary getting a payout when you die, you also save money over time. That last part of your life insurance policy is like a savings account attached to your policy. About one-third of your premium will add up over time. 

This is the difference between a term policy and a whole-life permanent policy. A term policy does not include cash value.

It's important to note that whole life insurance is meant to cover you for your entire life, from when you start the policy until you pass away. The cash value component offers a conservative savings or investment element, but it may not provide the same level of growth as more aggressive investment options.

Policyholders should review the terms and conditions of their whole life policy and consider their financial goals and needs before purchasing any insurance. And please, please, please get the help of a professional with good references and reviews.