What is cash value life insurance? How does it work?

The term “life insurance savings account” can have many aliases, such as “cash value life insurance,”  “life insurance with living benefits.” or even a form of “forced savings.” But, although it lives under different names, the concept stays the same—it’s a life insurance policy that also comes with a savings account component.

In its simplest form, cash value life insurance is like a policy that gives you two for the price of one: part life insurance and part savings account. When you pay your premiums, a portion goes toward your coverage plan, while another gets tucked away as a savings component that grows over time. 

What type of life insurance has cash value?

Cash value is typically offered through permanent life insurance. This can include: whole life, universal life, variable life, and indexed universal life insurance. Each comes with a different assortment of benefits and flexibility. 

Is it a good idea to use life insurance as a bank?

The primary purpose of life insurance is to ensure your family or loved ones are financially secure if you were to pass away. This can prevent them from taking on debts or outstanding bills you may leave behind. But the very idea that you could tap into some monetary benefits while you're still alive is pretty tempting. This is why, at first glance, life insurance with living benefits can seem like a great thing to acquire.

However, like any product with complexities, there’s often a mix of facts and fables. Some policyholders believe it's an excellent path to wealth. But how much truth is there to these claims? Let’s break down the idea of using life insurance as a bank and common misunderstandings when it comes to cash value. 

Misconception #1: Cash value is a good investment vehicle

While life insurance with a cash value component does offer a savings opportunity, likening it to traditional investment vehicles such as stocks, bonds, or mutual funds might be an overreach. For instance, the returns from a cash value insurance policy often don't match the potential gains one could achieve from stock market investments or real estate holdings. In essence, although it acts as a financial safety net, there might be better primary investment tools if you're aiming for substantial growth.

Misconception #2: You can’t lose money in a cash value account  

Let’s clear the air: cash value life insurance policies come with their share of fees and expenses. Moreover, returns on the cash value aren’t set in stone. If the markets dip or the policy’s investments don't perform as anticipated, your cash value might not look as rosy as you’d imagined. Of course, this isn’t always happening; however, it’s important to know this when applying for permanent life insurance with cash value. 

Misconception #3: Life insurance savings accounts are exclusively for the rich

Permanent life insurance that offers cash value, like whole life, can pinch your pockets way more than term life insurance. But no, it's not an exclusive club for the wealthy. It’s accessible to various income levels. 

While it requires a higher financial commitment, there can be various policy options to make it accessible to a broad range of income brackets. You should, of course, evaluate your financial situation and priorities. While some might find the benefits of cash value insurance aligning with their long-term goals, others might feel that a more budget-friendly and temporary coverage, like term insurance, suits their needs better. It's about finding the right fit for your unique circumstances.

Misconception #4: You can always access cash value tax-free 

While you can access the cash value in your policy, the tax treatment can be complex. Borrowing against the cash value or surrendering the policy may have tax consequences, and it's essential to understand these implications before making financial decisions.

Additionally, it's worth noting that it can take several years for a substantial cash value to accumulate in the policy. Plus, if you decide to borrow against this cash value, remember that the loan amount must be paid back with interest. Failing to repay can reduce your death benefit or even cause the policy to lapse. 

Misconception #5: Using life insurance as a bank is a great retirement haven 

The thought of using your life insurance policy as a retirement fund is appealing. After all, it promises access to funds in your lifetime. But is it the best route? While the cash value can act as a cushion, it might not be the most tax-efficient or cost-effective strategy for retirement savings. 

Traditional retirement funds, such as 401(k)s or IRAs, often come with distinct tax advantages and potentially higher returns over the long term. These established retirement plans are specifically designed for long-term growth and may provide more consistent benefits for your golden years.

On first inspection, life insurance with a savings component can be the more desirable and almost obvious choice to apply for. But peeling back the layers helps give a more keen understanding of what cash value fully entails. It's not about dismissing its benefits but rather knowing its ins and outs to see if it's the right choice for you. With innovative products coming out, like Savings+, the landscape of life insurance is ever-evolving. It's vital to stay on top of these changes if you want the most out of your financial protection.