If you have a permanent life insurance policy, there are two terms that you should familiarize yourself with: cash value and face value.
As the name suggests, a permanent life insurance policy offers permanent coverage because it offers coverage for the entire span of your life, rather than just a specific amount of time, like term life insurance. Whole life and universal life are two types of permanent life insurance policies.
Cash value and face value are features of a permanent life insurance policy. Both of these terms refer to the benefits that your life insurance policy offers, the meaning of these terms are very different; not only are they different to you, but they are also different to your beneficiaries.
What is the Cash Value and Face Value of a Whole Life Insurance Policy?
A percentage of the premium you pay for toward your whole life insurance policy is put toward the cost of the insurance, and the remaining amount is placed in a cash fund. The amount placed in the cash fund collects non-taxable interest. The amount of money that has accumulated is known as the cash value of the whole life policy. Only permanent life insurance policies, such as whole life and universal life, have a cash value account. The amount of money that your insurance provider put toward the policy is known as the face value and is the amount that will be paid out to your beneficiaries when you pass away. The face value of a whole life insurance policy is also known as the death benefit of the policy.
What Happens When You Pass Away?
When you pass away, your beneficiaries can file a claim with your life insurance provider. The amount of money they receive is the face value of your policy; they will not have access to the money that has accumulated in the cash account. In other words, they do not receive the cash value of your policy. For instance, if the face value of your whole life policy is $200,000 and the cash value that has accumulated is valued at $20,000 when you pass away, the beneficiaries of your policy will receive the $200,000 face value of your policy; the $20,000 that remains will be collected by the insurance company.
The Advantage of Cash Value
While your beneficiaries do not have access to the cash value of your whole life or universal life insurance policy, the cash value does offer benefits to you, the policy holder.
The money that accumulates in a cash value account on a permanent life insurance policy is tax deferred, meaning that it will not be taxed. If you decide that you want to take a loan out against your permanent life insurance policy, the funds will be withdrawn from the cash value account. This money is known as a living benefit and it is not taxable, nor does it have to be repaid. You can take a loan out against your permanent life insurance policy at any time, and for any reason.
You can also receive money from the cash value account of your universal life or whole life insurance policy by surrendering the policy, or cashing it in. However, if you decide to go with this option, your life insurance policy will be terminated. Furthermore, your insurance provider will subtract any charges that apply to the cash value of the policy; for example, if the cash value of your life insurance policy is $15,000 and your insurance carrier charges a 3 percent surrender fee, they will deduct $450 from the account and you will receive $14,550. However, in time, the cash value of your life insurance policy will match the value of the surrender fee, which would null any fees that you would be required to pay for surrendering the policy.
How Does Borrowing from The Cash Value Account Impact the Face Value of a Policy?
If you decide to borrow money from your whole life or universal life insurance policy, your coverage will not be terminated (unless you decide to terminate it); however, taking a loan out against your policy will reduce the death benefit. For example, if the face value of your permanent life insurance policy is $100,000 and you borrowed $5,000 against the loan, your insurance provider will subtract the outstanding $5,000 loan from the face value, meaning that your beneficiaries will receive $95,000 instead of the full $100,000 face value. Furthermore, any unpaid interest will also be deducted.
You can avoid having the face value of your policy reduced by repaying the amount you borrowed against your policy in a timely manner. As long as you pay back the full amount (plus interest, which is relatively low), your beneficiaries will receive the full face value amount of your permanent life insurance policy when you pass away.
Other Important Things to Note About Permanent Life Insurance
Permanent life insurance policies, such as whole life and universal life, provide your loved ones – and you – with premium coverage. Since this type of insurance is permanent, you do not have to worry about it expiring. However, with term life insurance, you will only be covered for a predetermined amount of time; if you outlive the term of the policy, you will need to take out a new policy.
Permanent life insurance policies are more expensive than term life insurance policies; however, the additional cost pays for premium coverage. As mentioned, not only does the value of this type of insurance grow over time, but you can also borrow money against it. Furthermore, these policies guarantee that you will have coverage for your entire life, ensuring that your loved ones will be provided for financially when you pass away.