Cash Value Life Insurance: How It Works and When to Use It

More than half of Canadians understand the importance of having life insurance, according to a recent insurance poll. But did you know there’s a particular type of life insurance policy that could also help increase your wealth? Cash value life insurance policy does just that. As well as offering permanent life insurance protection, it acts as a financial investment tool to help you accumulate wealth.

Discover what cash value life insurance is, how it works, and its benefits in deciding if a cash value life insurance policy is right for you.

Key takeaways

• A cash value life insurance policy combines permanent coverage with a savings component that accumulates over time.

• Policyholders have the option to access their cash value through loans, withdrawals, or policy surrender.

• Though cash value life insurance typically costs more than term insurance, it provides lifelong coverage and potential tax-deferred growth benefits.

What is cash value life insurance?

A cash value life insurance policy has two parts: a death benefit and a “cash value” component. The death benefit is the tax-free payout your beneficiary or beneficiaries receive after you die.

The cash value component is a tax-deferred savings feature that grows over time, meaning you don’t pay tax on any growth in the cash value—unless you access the cash value during the life of the policy.

Types of cash value insurance:

There are three types of cash value insurance: whole life insurance, universal life insurance, and participating life insurance. All three combine permanent life insurance coverage and an investment component.

Whole life

Whole life insurance is permanent life insurance that provides you with lifelong coverage—as long as you pay your premiums, which remain fixed—even if your health changes. Your beneficiary will receive a tax-free payment after you die. But while you’re still living, you can access the accrued cash value for what you need—for example, debt payments, charitable donations, or education.

Universal life

Universal life insurance offers flexible permanent coverage in addition to a cash value element. You’ll receive lifetime coverage, provided you pay your premiums.

How it works is a portion of your premiums go towards purchasing life insurance, while the remainder earns interest tax-free through an investment portfolio.

With universal life insurance, you have the flexibility to choose how your money will be invested for the purpose of earning interest or a licensed insurance advisor can help choose the right options based on your goals.

Unlike whole life insurance, universal life insurance allows you to raise or lower your premiums within certain limits to keep your policy in force – which also helps make it less expensive than whole life coverage. However, lowering premiums for too long it could affect how much your beneficiary receives after you die.

Participating life

A participating life insurance policy pools your premiums, as well as those of other policyholders, into a participating account that’s managed by a professional investment team with an insurance provider.

Also known as par insurance, a participating life insurance policy may pay out dividends to you, as the policyholder, on the policy’s anniversary. Your insurance provider calculates the yearly dividend payments using a formula known as the dividend scale. That dividend could then be used to: buy more coverage, be applied to your monthly premiums, paid out directly to you each year, or held on deposit earning interest.

How does cash value life insurance work?

Compared to term life insurance, cash value life insurance can be more complicated to understand. Here’s a breakdown of how it works:

Premium allocation

With a permanent life insurance policy, you must pay monthly premiums. These premiums are allocated toward three categories. One portion of your premium goes to the death benefit, another portion goes to your insurer, and the last portion goes towards increasing your policy’s cash value.

Over the course of your policy, the funds allotted to the cash value decrease and those paid to cover your insurance increase as you age. This is because the cost of insuring a life costs more the older you get.

Cash value growth

The cash value of your policy can grow over time, but it depends on the type of policy. A whole life policy usually involves less risk because it comes with a guaranteed cash value. On the other hand, the cash value growth in universal life and participating life insurance is variable, as it depends on the performance of the stocks, bonds, or mutual funds linked to the market.

Accessing cash

It typically takes between two to five years for the cash value to grow. As it does, you may be able access cash from your policy—for any life emergencies or to help fund a major purchase—in the three ways.

Policy loan: You may be able to take out a loan against a portion of the cash value in your policy. You won’t be able to take out the entire amount because the loan balance and interest charges reduces the net cash value, effectively cancelling your policy and your coverage will end.

Withdrawals: Depending on the accumulated cash value, you may be able to withdraw a portion of the cash. It’s important to note that there may be tax implication, and your beneficiary would receive less money after you die.

Surrender the policy: When you surrender your policy, you basically cancel your policy with the insurance company to receive the full cash surrender value—minus any loans, loan interest, outstanding premiums, or surrender fees.

Your insurance company will pay you the cash surrender value, if there is any available, and your beneficiary will not receive any death payment in the event of your death. In addition to your life insurance coverage ending, some or all the money you receive may be subject to tax.

Benefits of cash value life insurance

Cash value life insurance has many benefits, including permanence. Your insurance coverage is in place for your entire life, provided you pay your premiums. This differs from term life insurance, which covers you for a fixed period, typically between 10 and 30 years.

Here are a some of the benefits of cash value life insurance:

Flexibility 

Cash value life insurance provides financial flexibility. As the policyholder, you could access funds for rainy-day emergencies, education, or retirement or estate planning. In a participating cash life insurance policy, you can use yearly dividends to help pay your premiums or increase your coverage.

Tax advantage

The cash value component of your policy grows on a tax-deferred basis. This allows your savings to accumulate faster than in a taxable account. And, if you need to borrow against the cash value component your policy, you could do so tax-free.

Growth

A whole life insurance policy provides predictable cash value growth.However, if you have a variable cash life policy, the cash value of your policy may increase or decrease depending on the performance of the type of investments you choose, which are linked to the market.

Disadvantages of cash value life insurance

While cash value life insurance has benefits, there are also some disadvantages. It’s important to understand what they are as cash value life insurance may not be the right product for you.

Complexity

Cash value life insurance policies are generally harder to grasp as they’re more complex than term life policies. You’ll need to ensure you understand the policy terms, the difference in fees, and your investment options. These all vary depending on the type of cash value life insurance policy you purchase. If you have questions, an accredited insurance broker can help.

Higher premiums and charges

Typically, cash value insurance policy is more expensive than term life insurance; in some instances, premiums can be five to 15 times higher than term life coverage. It’s important to consider how cash value insurance fits in your budget and investment goals. In addition, if you surrender your policy early (i.e., cancel your policy), you could pay significant fees, and you will lose your coverage.

Opportunity cost

With cash value life insurance, you’re generally paying higher premiums. Consider the opportunity cost compared to other savings vehicles such as a Registered Retirement Savings Plan (RRSP) or Tax-Free Savings Account (TFSA).

Policy lapses

As the policyholder, if you fail to pay the required premiums, your life insurance policy will lapse, meaning you will no longer be covered. In the event of your death, your beneficiary will not be eligible to receive the death benefit payout.

When to use cash value life insurance

Your decision to buy a cash value life insurance policy will depend on your unique situation and how much flexibility you need.

Long-term financial goals

A cash value life insurance policy may be suitable for individuals with long-term goals, such as retirement planning or leaving a legacy for family or loved ones.

Estate planning

With a cash value life insurance policy, you can plan for your future with confidence as the death benefit is guaranteed. After you die, the cash value life insurance policy can help with estate planning by covering estate taxes, and ensuring your beneficiary or beneficiaries receive their intended full inheritance.

High net-worth individuals

If you’re a high net worth individual, you may want to explore the possibility of a cash value life insurance policy – especially if you’ve maximized your other tax-advantaged accounts such as RRSPs and TFSAs.

Business owners

As a business owner, you may find a cash value life insurance policy useful as an executive compensation strategy, as a buy-sell agreement, or as collateral for a loan.

How to choose the right cash value life insurance policy

Choosing the right cash value life insurance policy will depend on your financial goals, personal needs, stage of life, and what you can afford.

Cash value life insurance may be beneficial if you if:

• You want life-long insurance coverage

• You have reached the limits on your other tax-advantaged accounts and want another tax-deferred savings vehicle

• You want predicable growth and a guaranteed death benefit for your beneficiary

• Plan to use policy loans in retirement for tax-efficient income

• You are a high earner or business owner and want both life insurance and an investment component

• You want to ensure more of your estate stays intact when you pass away

Assess your financial goals

Consider your financial goals. Think about what you want or need your money for. Retirement? Estate planning? Your business?

Compare policies

Choosing between whole life and universal life insurance depends on your circumstances and needs. Whole life insurance might be right for you if you want a simple plan with guarantees and fixed premiums. Universal life insurance may be ideal if you want payment flexibility and are willing to actively manage your policy.

Evaluate costs

Remember, a permanent life insurance policy is typically more expensive than a term life insurance policy. In addition, if you choose a variable cash life policy, the cash value of your policy may increase with your investments, but it may also decrease.

Work with an accredited advisor

As with most things in life, if you’re not 100% sure which insurance product is right for you, consult with a licensed advisor. They can guide you to the policy that aligns best with your overall financial plans and goals.

Is cash value life insurance right for you?

Cash value life insurance policies combine insurance coverage with savings and investment growth, which can be a benefit in long-term financial planning. While cash life value insurance policy may not be right for every Canadian, it can be a powerful tool if you have specific financial goals and can commit to lifelong premiums.

FAQs about cash value life insurance

Is cash value life insurance worth it?

Cash value life insurance may be worth it for you. The policy is in place for your entire life, if premiums are maintained, and your family and loved ones will receive a guaranteed benefit after you die.

Can I cancel my life insurance policy and get my money back?

Yes, you can cancel your policy and take the cash value, but the cash value you’ll receive will be minus any surrender charges. A surrender charge is a fee you, as the policyholder, pay when you cancel your life insurance policy.

What is the downside of cash value life insurance?

Cash value life insurance premiums tend to be higher than term life insurance premiums. In the end, you could end up paying more in premiums over the course of your life—possibly more than what your policy’s death benefit is worth.

Share This Article