Whole life insurance policies accumulate cash value over time, which is accessible to the policy owner. The increasing value comes from money not used for the expenses of the company and claims. The money earns interest and may be borrowed.
Function:
The cash value feature of a whole life policy is basically what distinguishes it from a term life insurance policy. Term life is often referred to as pure insurance and has no frills with it, enabling it to be the much less expensive option. The cash value of a whole life insurance policy provides policy owners with the option to get cash from their policies if it is ever needed.
Types:
Different types of whole life insurance policies or permanent life have different ways to collect cash values. A standard whole life insurance policy earns about 1 percent interest and the rate and value are printed in the policy.
A universal life insurance policy builds cash value from the company’s investing the money in market-based instruments such as money markets or stocks and bonds, but also will guarantee minimum cash value at about 4 percent. A variable life policy and a universal variable life insurance policy both use market-based instruments and leave it up to the consumer as to where the money is to be invested. In both of these types of investments, all money may be lost.
Considerations:
Dave Ramsey, host of a nationally syndicated financial advice show, says that in the first few years of a permanent life policy most of the premiums paid go toward commissions and various company expenses. This is why this type of policy sees almost no cash value at the beginning of it. He also says that insurance is not the proper instrument for investments.
Some insurance companies will pay dividends, which are simply a return of part of the premiums when the insurance company has a good year. Dividends are not guaranteed and do not affect the cash value.
Misconceptions:
A common misconception about all permanent type of life insurance policies is that people end up believing that the cash value is received in addition to the insurance face value amount if the insured dies. The truth is that only the face value amount of the policy is awarded to the beneficiary. As the policy gains in cash value, the insured is actually insuring themselves and there is less and less risk to the insurance company, until when fully mature, there is no risk at all to the company–the savings portion is equal to the face value.
Warning:
Borrowing the cash value out of your policy means that you have that much less coverage, unless it is paid back. An interest rate of about 8 percent accumulates on the borrowed money which means it is constantly becoming less and less if you borrow the cash value. A “surrender value” amount is also given in a cash value insurance policy and it will cancel the policy.