Cash Value: A Life Insurance Savings Account

Saving money saves lives. When you have money stored, you are better able to navigate life’s trials as well as the joys. The question is, where do you put the money you save? And what is your wealth protection strategy? We suggest a whole life insurance policy with a mutual company. 

Can I Use Life Insurance as a Savings Account?

One of the many reasons we love whole life insurance is because it is the “both/and” asset. As in, you don’t have to choose between “either/or,” life insurance OR savings. Thanks to the cash value component of whole life insurance, you can use your life insurance policy like it’s a savings vehicle. And beyond simply being possible, there are actually some compelling reasons to save into a life insurance policy over a bank savings account.

What is Cash Value Life Insurance?

Strictly speaking, a life insurance savings account isn’t a thing–it’s a “cash value” component of your whole life insurance policy. This means that when you buy a permanent policy, the life insurance company agrees to allow you access to the equity of your policy while you’re alive. This equity grows every time you make a premium payment, just like your home equity grows with each mortgage payment. Because of this, it functions similarly to a bank savings account. You put money in and allow it to accumulate it. 

How Does Cash Value Life Insurance Work?

Cash value life insurance works like any life insurance policy in that you pay your premiums in exchange for a death benefit. However, whole life insurance (which is the preferred cash value life insurance vehicle) also has the cash value component.

In addition to building cash value through your premium payments, you can earn interest and dividends on your cash value. In order to do this, you must have a policy with a participating mutual insurance company. This means that you get to participate in company profits because the company is owned by policyholders. Whenever the company profits, you get to enjoy that in the form of dividends and interest.

How a Life Insurance Savings Account Differs from a Bank Savings Account

While the basic concept is the same–put money into an account and leave it alone–a life insurance savings account differs from a bank savings account in a few ways. The first difference is that a savings account at the bank usually only pays a nominal interest rate. You may get a point and a half, or even two, but not much more than that. 

On the other hand, with whole life insurance, you earn interest and dividends. You are guaranteed to see your account increase by a certain dollar amount each year—this is the interest. You get this increase regardless of the company’s performance. Dividends are not guaranteed, yet they are expected. The major mutual insurance companies all have great track records of profiting (thus paying dividends) over the last hundred years or so. This means they made a profit during every recession, war, and other economic hardship, thanks to their conservative financial practices. All in all, life insurance cash value tends to earn a Net of 4% or so (interest and dividends combined), which is a big improvement from 1-2%. 

What’s even better is that any time your cash value goes up–whether from interest, dividends, or premiums–that is the new guaranteed floor of your CV. You can’t lose money, no matter what’s happening in the stock market. That floor only decreases if you make a withdrawal.

Another way that a life insurance savings account differs from a bank account is the ability to access cash without withdrawing. This is thanks to the policy loan provision. While yes, this does mean taking a loan, the loan terms are extremely flexible because you have the cash value to back it up. Meanwhile, your cash value continues to earn interest and dividends on the full volume of cash. This makes your cash accumulation much more efficient in the long run. 

Does All Life Insurance Have a Cash Value Component?

Unfortunately, no, not all life insurance products have a cash value. This is an instance of “you get what you pay for.” Term insurance has a reputation for being the most affordable insurance, and whole life the most expensive, however, there’s a little more to it than that. 

With term insurance, you’re simply paying for temporary coverage. There’s certainly a time and a place for this, and term insurance is a great place to start for many people. However, there are no perks beyond that. Whole life insurance, on the other hand, is permanent. The cost of the insurance goes up because you’ve gone from a possible claim to a guaranteed claim (as long as you keep the policy). The cash value is the insurance company’s way of offering additional value to you because of this cost. 

It is possible to have a cash value component with universal life insurance, however, we don’t recommend it. The unfortunate problem with UL is that the cash value is tied up in the stock market. While this may sound good, it opens the policy up to unnecessary risk. All the guarantees that make your whole life insurance cash value so great go out the window with universal life because nothing is guaranteed. We’ve seen many policies implode because the cash value had to be consumed in order to cover the ever-increasing costs of the policy.

How Long Does it Take to Build Cash Value?

Cash value can take some time to build because, in the early years of your policy, it doesn’t increase dollar for dollar when you pay premiums. This is because the insurance company has to use some of that premium to cover the cost of insurance. Costs include building overhead, employee wages, and many other costs of running a business. Fortunately, the insurance company designs your policy so that those costs decrease over time as the risk to the company lessens. 

This means that in about 7-10 years, your cash value “breaks even.” The break-even point is the point at which your cash value is equal to every dollar of premium you’ve paid. And once you reach this point, your cash value reaches velocity and actually becomes much more than what you’ve put into it. 

So it takes patience to see it through, yet once you reach the break-even point, your cash value soars and you’ll be glad you did it. After all, it’s a replenishing pool of capital. 

Unfortunately, universal life insurance is not structured in this way. Rather than having the costs built into the premiums so that they lessen over time, the costs of the policy fluctuate with the market. In some cases, the costs can actually be more than the premium, causing the cash value to decrease. This is a double whammy when the market is bad. Even if your policy is designed with a 0% floor, those insurance costs don’t disappear, so you can still lose money. 

How Can a Life Insurance Savings Plan Be Used?

The good news is, you can use a life insurance savings plan however you wish. While we recommend using a policy loan to access your cash (in order to benefit from the uninterrupted compounding), there are no requirements for a loan. What this means is that if you want access to your cash, all you have to do is tell the insurance company, and they’ll put it in motion. There’s no application or qualification process, like with a bank loan.

This means you can use your life insurance savings for anything from a new car to a vacation, college tuition to a rental property. 

And, once the money hits your account, there’s no ticking clock on how to repay that loan. You can pay it down a few times a year, in a lump sum, or every month for 36 months if you want. If you want to wait a year, you can do that, too. There is interest on the loan, yet that interest goes to the insurance company. And as a mutual policyholder, a win for the company is a win for you.  

The long-term benefit of accessing your cash this way is that you can use and replenish your pool of cash without losing the opportunity cost of those interest and dividends. This means your pool of capital is ever-increasing, too, providing you and your family with more opportunity and peace of mind. 

Does a Life Insurance Savings Account Increase My Policy Cost?

Remember, you can’t get something for nothing. While having a life insurance savings account, AKA your cash value, doesn’t increase the cost of your policy, cash value insurance does cost more than term insurance. In that way, you are paying more. However, you get the added benefit of permanent insurance coverage and other benefits.

It is possible to purchase PUAs (paid-up additions) on your premium, which helps you accelerate your cash value growth. We see these as additional savings contributions, not increased costs, and they are completely optional.

Universal life insurance is often marketed as a cheaper alternative to whole life insurance, yet the products really don’t have much resemblance. If you want cash value that’s guaranteed not to decrease as well as a premium that’s guaranteed not to increase, whole life insurance is the way to go. This is one instance where you do get what you pay for. 

Plus, whole life premiums are a fixed payment, which means they get better with inflation.

The Benefits of Savings with Life Insurance

Ultimately, there are many benefits of savings with life insurance. In addition to the interest, dividends, and policy loan provision, here are some other benefits of savings with life insurance.

  • Your policy is shielded from prying eyes. The IRS, creditors, and other institutions don’t know how much life insurance you have, including the cash value. You don’t even have to claim it on FAFSA forms.
  • Cash value is valuable collateral for banks, too. If you can get a better interest rate with the bank, consider using your policy as loan collateral there. Cash value gives you options. 
  • Payments show up like a bill. How often do you contribute to your savings? How often do you pay your bills? Chances are you always pay your bills, and you sometimes pay your savings account. When your savings shows up like a bill (premium), you’re going to make it happen. 
  • Tax-free access. When you use the loan provision, you actually get to access your money without causing a taxable event. You can even withdraw up to the basis (what you’ve contributed) tax-free. When you pass, the death benefit goes tax-free to your heirs.
  • You have a pool of money that does multiple jobs. You can use it for fun, for business, for emergencies, for school, and many other things. Effectively, you’re recycling money. That way you don’t have to fill ten jars with ten dollars, you can fill one jar with ten dollars. Then, that money gets passed to your heirs. 

Is Cash Value Life Insurance Bad?

Cash value insurance can get a bad rap because it’s labeled as expensive or ineffective. Yet when you understand the value of it, and how to make your policy as efficient as possible, you’ll see that’s not the case. If we can answer any of your questions or help you learn and apply this information, please send us your questions at welcome@prosperitythinkers.com. We would be happy to help you as you learn more.
To get started with your savings journey, you can book with us today.

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