If you buy a whole (or permanent) life insurance policy, then part of the premiums you pay go toward the accumulation of cash values on the policy. Cash values are cash reserves that can earn interest through either fixed rates or variable rates dependent on stock or index performance.
Most life insurance policies are only in-force as long as the premiums are paid and the cash values are not equal to the death benefit. Once the cash values do equal the death benefit (usually by the time the insured reaches age 99), then the cash values are given to the insured. Cash values are created with after-tax dollars, and the growth is not taxable as long as they remain in the policy (or temporarily loaned out) and the values are not growing so rapidly that they threaten to become equal to the death benefit before age 99 (a situation known as a Modified Endowment Contract, or MEC).
What this Means to the Average Policyholder
The average life insurance policyholder can benefit from cash values in many ways. First, cash values can be used to fund unpaid premium payments and keep a policy in-force during a financially lean period. This is known as an applied premium loan.
In addition, cash values can be accessed to provide tax-free loans during pre- and post-retirement. While these loans must be paid back (unpaid loans may reduce death benefits paid to heirs), the interest that is paid on them is paid to you, the lender, which is a very favorable alternative to a traditional loan. Speaking of loans, life insurance cash values also factor into your overall net worth and can be used to help a financial institution consider you for a loan.
Lastly, if you wish to cancel a policy, you can surrender it for the amount of the cash value and basically get a refund of some of the premiums, although you may need to pay taxes on any gains.
Life Insurance Policies as Investments
All of this information may make you consider life insurance policies as a form of investment, which is true to an extent as you do get the growth of the cash value. But technically, a life insurance policy is a form of protection for your loved ones, not a legitimate way to invest and grow your savings. Unless considering a 5-pay life plan, your cash values will grow much more slowly than traditional investments such as stocks, bonds and mutual funds may. In addition, you do not have the freedom to invest in a wide range of stocks and mutual funds, but only those your insurance company has chosen for subaccounts. And finally, treating a life insurance policy as an investment subjects you to interest rate risk since the fixed interest in the cash value will not increase over time, whereas CD, annuity and other rates will.
For more information about Chandler life insurance, give Taylor Insurance a call at (480) 267-9220.