How does a life insurance policy help you build savings and wealth?

There are two basic types of life insurance – permanent life insurance and term life insurance. It’s important to note that term life insurance is not an appropriate choice for those that wish to have life insurance with cash value. Why? Because while a term life insurance policy offers a death benefit like permanent life insurance, coverage is temporary and doesn't allow the policyholder to build cash value.

Permanent life insurance policies come in two forms – whole life insurance and universal life insurance.3 Both are also known as cash value policies because they not only pay a death benefit but also have a built-in component that lets you build cash value over time. These funds are available for any purpose while you are still alive, from paying college tuition to buying a new car or even helping to fund your retirement.4 Many permanent life insurance policyholders use their cash value to pay their life insurance premiums in the later years of their policy. Here's how it works:

When you pay your policy premium, a portion goes towards the cost of insuring you, a portion goes to the insurance company's fees, and a portion goes to the policy’s cash value.

Depending on which type of whole life or universal life insurance policy you choose, your cash value will grow either by earning guaranteed interest or by accruing gains from subaccounts or other investment vehicles. It is important to note that interest and gains accrue on a tax-deferred basis - a key advantage that life insurance has over many other financial vehicles. Then, after you have built up cash value, there will come a point when you are allowed to access the cash. You can do this in three ways:

  • Withdrawal. You can simply withdraw some of the cash value. But be aware: This will reduce the death benefit in most cases. So if your goal is to maximize that benefit for future protection, you might want to avoid straight withdrawals unless it is an emergency.
  • Loan. You can take out a loan against the cash value of your policy. Then, you have a choice. You can pay back the loan - with interest - which will preserve the death benefit at its original amount. Or you can choose not to pay back the loan or the interest – in which case the death benefit will be reduced by the loan amount. Either way, a loan has an advantage over a withdrawal: The funds for the loan come from the insurance company - not from your policy's cash value - so whatever cash value you have built up continues to earn interest or investment gains even while the loan is outstanding.
  • Surrender. You can receive the entire cash value of your life insurance policy (minus any applicable surrender charge) by terminating – or “surrendering” – your policy. When you choose this option, your life insurance coverage will end, as will your premium payments. Please remember to ask your life insurance company about possible tax consequences before moving forward.

As mentioned above, you can also use the accrued cash value to pay your life insurance premiums in the later years of your coverage. Many policyholders who don't need the funds for other purposes choose this option.

Which cash value life insurance policy is right for you?

When you choose to get a life insurance policy for savings, you'll then have to decide which of the various policy types is best for your needs. This decision should be based on the type of coverage offered, the cost of the premiums, and – importantly – how the cash value portion works. Each policy type works somewhat differently, with the most significant difference being the specific cash value and investment options offered.

Whole Life Insurance

  • With whole life insurance, your cash value accrues at a fixed interest rate. In addition, whole life insurance offers fixed monthly premiums, a guaranteed death benefit, and – in some cases – dividends from the insurance company.5 With its guaranteed premium, interest rate, and death benefit, it is a simple and stable choice but often more expensive than other policy types.

Universal Life Insurance

  • With these policies, cash value is guaranteed to grow at a specified minimum interest rate, and while these insurance policies don’t earn dividends, account value can grow faster than the guaranteed rate depending on the insurance company’s investing performance. But there’s a key difference compared to whole life: the premiums are variable. You have the flexibility to raise or lower your premium payments as you see fit, within the limits of the policy.6  This gives added flexibility to people with variable incomes. There are also variations on universal life that provide more growth potential along with a degree of investment risk:
    • Indexed universal life7: your cash value is tied to the performance of an index such as the S&P 500, with caps for minimum and maximum rates of return which limit your investment risk and growth potential.
    • Variable Universal Life Insurance8you allocate your cash value into grouped stock market and bond investments called "subaccounts." With this type of policy, you assume all the investment risk but can also benefit from upside growth.

 If you are concerned about your dependents’ financial protection in the event of your death, and you can afford to invest in a cash value life insurance policy, it may be worth considering. Consider: a cash value life insurance policy offers guaranteed financial protection in the event of your death and a tax-advantaged way to build your net worth while you are alive. Other financial vehicles may not provide both. While they may or may not produce higher returns than a life insurance policy, they may not deliver an income tax-free lump sum payment if you pass away. And unless they’re in a retirement account, those investments may not offer the generous tax advantages of a life insurance policy. So no matter what other financial assets you already hold, it may be worth adding permanent life insurance to your portfolio.

How to get started

If you think that a life insurance policy may be right for you, we suggest talking to a knowledgeable professional who can answer detailed questions about the different types of policies discussed above and help you to make a fully-informed decision. If you don't have someone to discuss insurance with, Guardian can help you find a nearby financial representative who will take the time to learn about your situation and present you with options that will best fit your current and future financial needs.

Frequently asked questions about life insurance to supplement savings

What is a life insurance cash value?

Certain types of life insurance serve two purposes. Most importantly, they pay an income tax-free, lump sum death benefit to your dependents in the event of your death. But they can also serve as a tax-advantaged wealth-building vehicle that can supplement other savings, investments, and retirement accounts.

Which life insurance is best to supplement savings?

Whole life insurance policies and universal life insurance policies both offer a cash value component. Which is most appropriate for you depends on your financial situation and needs. Remember: Term life insurance policies do not offer a cash value component and are not typically used to supplement savings.

How does a cash value life insurance policy work?

A portion of your premium payment goes into the policy's cash value, which accrues either interest or market returns based on other investments. Your life insurance values grow on a tax-deferred basis, and the cash can be accessed by you while you are still alive.

What type of life insurance is least expensive because it does not build cash value or serve as an investment?

Term life insurance is generally the least expensive option - because your monthly payment only covers the cost of insurance. None of the payment is applied to a cash value component. The good news? You can pay less in premiums today. The bad news? The policy will not have any cash value moving forward, other than the death benefit itself.

Which type of life insurance has the most cash value savings accumulated in it?

With a whole life insurance policy, your cash value accrues with a guaranteed interest rate. If it's from a mutual company, such as Guardian, it may also earn dividends, but these are not guaranteed. Depending on the type of universal life insurance policy, your cash value can be tied to a market interest rate, an investment index – such as the S&P 500 – or investments in subaccounts. These policies can potentially deliver higher cash value than a whole life policy, but they may deliver lower gains if the stock market or prevailing interest rates decline.

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This article is for informational purposes only. Guardian may not offer all products discussed. Please consult with a financial professional to understand what life insurance products are available for sale.

1 All whole life insurance policy guarantees are subject to the timely payment of all required premiums and the claims paying ability of the issuing insurance company. Policy loans and withdrawals affect the guarantees by reducing the policy’s death benefit and cash values.

2 Some whole life polices do not have cash values in the first two years of the policy and don’t pay a dividend until the policy’s third year. Talk to your financial representative and refer to your individual whole life policy illustration for more information.

3 Permanent life insurance consists of two types: whole life and universal life. Cash value grows in a participating whole life policy through dividends, which are declared annually by the company's board of directors and are not guaranteed. Cash value grows in a universal life policy through credited interest and decreased insurance costs. The cash value of both policy types benefits when the policyholder pays an amount above the required premium.

4 Policy benefits are reduced by any outstanding loan or loan interest and/or withdrawals. Dividends, if any, are affected by policy loans and loan interest. Withdrawals above the cost basis may result in taxable ordinary income. If the policy lapses, or is surrendered, any outstanding loans considered gain in the policy may be subject to ordinary income taxes. If the policy is a Modified Endowment Contract (MEC), loans are treated like withdrawals, but as gain first, subject to ordinary income taxes. If the policy owner is under 59 ½, any taxable withdrawal may also be subject to a 10% federal tax penalty.

5 Dividends are not guaranteed. They are declared annually by Guardian’s Board of Directors.

6 Universal Life Insurance may lapse prematurely due to inadequate funding (low or no premium), increase in cost of insurance rates as the insured grows older, and a low interest crediting rate. This does not apply to universal life policies which have a secondary guarantee, but if the secondary guarantee requirements are not met the policy will most likely lapse.

7 An Indexed Universal Life (IUL) policy is not considered a security. Premium and death benefit types are flexible. It’s crediting rate is based on the performance of a stock index with a cap rate (i.e. 10%), a floor (i.e. 0%), and a participation rate (i.e., 100%). This type of universal life policy may lapse due to low or negative performance of the stock index, inadequate funding, and increasing cost of insurance rates.

8 A Variable Universal Life (VUL) policy is considered both life insurance and a security and is sold with a prospectus. Premium and death benefit types are flexible. It’s crediting rate is based on the performance of the underlying investment options provided in the policy. There is no guaranteed interest rate. This type of policy may lapse due to low or negative performance of the underlying investment options, inadequate funding, and increasing cost of insurance rates. See your policy prospectus for more information.

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