If you are trying to learn more about life insurance before making a purchase, you might have come across the term ‘cash value’ of the policy. Check out this post to know what it is and how it can benefit you.
While the primary purpose of all the different types of policies, ranging from term plans to whole life insurance plans and ULIPs, is to insure your life, they do have many noticeable differences too.
For instance, one of the most significant difference between them is that term insurance does not have any ‘cash value’ but whole life and universal insurance do come with this built-in benefit. What is this ‘cash value’ and does it make whole life and universal plans better than term plans? Let us have a look-
What is Cash Value in Life Insurance?
The premium of the life insurance plans with cash value is divided into two parts- one part is used for purchasing life cover, and the second part is invested, generally in a conservative-yield fund. This second part of the premium helps build the cash value of the policy as it earns interest or returns with time.
On maturity, you will receive the cash value of the policy as the maturity benefit, and the life cover will cease. Even in case if you’d like to surrender the plan for some reason before maturity, you will receive the cash value of the policy accumulated till date but after certain deductions as per the terms and conditions of your policy.
How is the Premium Amount Divided into Insurance and Investment?
The division is similar to the division of the interest amount and principal amount in home loans. In the initial years of the loan, the interest amount is higher than the principal amount in the EMIs you pay. Over the years, the interest amount falls and the principal amount increases while the EMI amount remains the same.
Similarly, in policies with cash value, the investment component is higher than the insurance cover in the initial years of the policy. As you age, the insurance cover starts getting more expensive; a higher part of the premium is then dedicated to the same, and the investment component falls.
What Can Be Done with Cash Value of Life Insurance?
The fund in which the money is invested generates modest interest every year. But over 20-30 years, the compounding effect can help you build a sizable cash value portfolio even with modest returns. Moreover, once you have a sizable cash value, it can be used in a few different ways such as-
- Taking a loan against the amount at a rate cheaper than most retail loans
- Use the amount for paying the future premiums of the policy
- Use it for earning retirement income
- Use it for repaying loans or for financial objectives like higher education or marriage of children, etc.
Does This Make Whole Life Insurance Better Than Term Plans?
Not really! All the different types of insurance plans come with their own benefits. For instance, in the case of term plans, you get to benefit from higher life cover at lower premiums. This makes the term plan an excellent choice for someone who has recently started working and could not afford the high premium of the whole life insurance policy.
If you are planning to purchase life insurance anytime soon, try to thoroughly understand all the different types of plans and their benefits before making the decision. Even if a policy with cash value is what you are interested in, try to know more about how cash value grows and what can be done with the accumulated amount at a later stage in your life.