The Basics of Cash Value Life Insurance

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An excerpt from Follow the Money Weekly Radio with Jerry Robinson

by John Bearss

Transcript: Over the last two weeks I have been talking about why cash value life insurance should be considered when developing a person’s overall retirement planning strategy. I have had many of the listeners e-mail me concerning more details as to what are the advantages and disadvantages of using cash value life insurance as a part of the overall financial plan. So today, I want to answer some of those questions.

What is Cash Value Life Insurance?

Let’s start out by determining what cash value life insurance is. When you pay premiums on a cash value life insurance policy, some of your money is applied toward the policy cash value, which is similar to a savings account within the policy. Over time, the cash value accumulates. At any time in your life, you have the ability to access the cash value by taking a withdrawal, known as a policy loan. You can also liquidate the funds by surrendering or canceling your policy.

Can I withdraw money from my cash value life insurance policy to help pay for private elementary education for my children?

It is unlikely that many parents of elementary school age children will be able to utilize the cash value in their life insurance policies to pay for private school tuition, unless they have purchased the policy well in advance of their children being born. The reason is that it can take several years, usually 10 or more, before the cash value within your policy will build up to a sizable amount. However, for most people, if they have started the policy when the children are young they could easily use the cash value to help pay for college expenses.

What are the benefits of using cash value life insurance as a savings vehicle?

Admittedly, many people never consider a cash value life insurance policy when choosing a savings vehicle. However, the benefits of using a life insurance policy to accumulate savings are numerous.

First of all, if a sudden tragedy were to strike and you passed away, a death benefit would be available to your beneficiaries. And under most circumstances, this death benefit will be paid to out income tax-free. This is a huge benefit, especially to a younger couple with children. If death comes prematurely, your life insurance death benefit would ensure that your children had enough money to pay for their college costs. This one benefit alone far outweighs putting cash into a simple savings account. Sure there are some internal costs associated with a cash value life insurance policy. But those costs are actually being used to pay for very important benefits.

Now, let’s consider another scenario where you do not die prematurely. Let’s say instead that you have saved money in your cash value life insurance policy planning to use it for your children’s college costs. And then let’s say that they decide not to go to college? Well, as the owner of the life insurance contract, you can use the money for whatever you want. Let’s say you want to help them with a down payment on a house or maybe even to help supplement your own retirement income. The point is how you use the money is your choice. (Compare this to the often touted 529 educational plans. Savings placed into these plans must be used for college. If not, then you will have to pay a sizable penalty to the federal government plus federal and state taxes before you get a dime back. No thank you!)

Another benefit is that you can put as much money into a cash value life insurance policy as you want. There is no limit to the amount you can contribute. Now remember, there is no upfront tax benefit for the amount you contribute. However, while the money is growing inside the cash value life insurance policy it is growing tax-deferred meaning that while it is growing you do not receive a 1099 for the growth each year. This is important because money will grow faster if you do not have to take money out of the contract to pay taxes each year. And most important, when you start to take a distribution from the contract it is not considered reportable income. In other words, there is no line on the 1040 tax form that asks how much money you received from your cash value life insurance policy? This is especially helpful for grandparents who buy a cash value life insurance policy with the intent of helping their grandchildren. Why? Because if a grandparent is retired and receiving a social security benefit, distributions taken from their cash value life insurance policy, if done properly, are not considered reportable income and will not increase the taxes on their social security benefit income. So even if you are only using this income to supplement your own retirement income, it will not affect the taxes on your social security benefit because again, it is not considered reportable income.

In part two of this article series, I will discuss the different methods of taking withdrawals from your cash value life insurance policy and the rules that apply to each method.

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