What Is Cash Value Life Insurance?

The primary purpose of life insurance is to provide financial support to your beneficiaries in the event of your death. Every type of life insurance policy has a regular cost (called a premium) based on your life expectancy and the type and amount of your insurance coverage.

A term life policy provides insurance coverage for a specific period of time (term). At some point in the future, depending on the particular policy design, the premiums may begin to increase annually according to your age. The older you get, the more pricy a term policy can become, and you never receive a benefit from it, though your beneficiaries will if you die. If you try to hold onto it into later years, you might end up paying total premiums greater than the value of the death benefit.

A permanent life insurance policy covers you for life as long as you make your premium payments. The most traditional form of permanent life insurance is whole life. Once you are approved for the policy, the insurance company cannot cancel the policy, and the cost of your payments will not go up, because it "averages" insurance costs over your lifetime.

Premiums for whole life policies are initially higher than those for term, but over the long run can end up lower and sometimes much lower.

There are also variations on the whole life insurance theme. Relative newcomers to the permanent insurance world include universal and variable life insurance.

• Universal life insurance allows flexibility in both the premium and death benefit.
• Variable life insurance allows more control over the investment of the "cash value."
• Variable universal life combines elements of both universal and variable life.

We will focus on the elements of cash value life insurance common to all forms of permanent insurance.

In addition to covering the current risk of the death benefit, part of the premium you pay for permanent insurance is invested in the company's general account or separate account, depending on the type of policy you purchase. This portion of your premium makes up the policy's cash value and increases with additions and earnings. A policy's cash value is different from its face value. Face value is the amount of a policy paid to your dependents when you die, and the cash value is a component of this death benefit.

Cash value is the amount you will get if you surrender (cancel) your policy before you die. You can borrow this amount at any time in the form of tax-free loans. You may even make policy loans to pay your premiums. All components of a whole life policy are guaranteed—premium, death benefit, and cash value. With universal and variable life, only the death benefit is guaranteed.

One way to understand how whole life policies work as compared to term policies is to compare them to buying or renting a house. Like buying a house, whole life policies provide the benefit of building up equity, or the cash value. When you rent a house, you get the benefits of living in the house, but when your lease is up, you leave with no equity—likewise with a term policy. When you buy a house, you also build up extra value that is yours when you sell the house. This is similar to the way a cash value policy works.

Your insurance company invests the cash value of your policy in securities. With whole life policies, it is usually invested in high-grade income securities. With whole life insurance, you received a fixed return on your cash value. With universal and variable life, good investment performance can lead to higher cash values, higher death benefits, and/or lower premiums. Other factors that can affect performance of your policy are the company's experience in mortality (death claims) and expenses.

If you like the idea of combining insurance protection with an investment for the future, a cash value life insurance policy may be for you.

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