Life insurance provides more than just a safety net for you and your family. It’s also an investment opportunity for many Canadians, especially considering cash-value life insurance policies. But what exactly is the cash value of a life insurance policy, and how does it work? In this guide, we’ll delve deep into the concept of “cash value life insurance” and its significance in the Canadian insurance landscape, as highlighted by the Financial Consumer Agency of Canada.
What is Cash Value Life Insurance?
Cash value life insurance represents a type of enduring life insurance designed to remain valid throughout the policyholder’s life. It comes equipped with a distinct savings element known as the cash value. This segment of your policy accumulates interest and offers the flexibility to withdraw or take loans against it during unforeseen situations. Beyond merely serving as a death benefit, it is a versatile financial instrument catering to diverse requirements.
Types of Life Insurance with Cash Value
Several types of permanent life insurance policies offer a cash value feature:
- Whole Life Insurance: Provides a guaranteed death benefit, fixed premiums, and a cash value component that grows at a guaranteed rate.
- Universal Life Insurance: Offers flexible premiums and a death benefit, with a cash value component that can earn a market rate of return. If you’re trying to decide between these two types, our article on Whole Life Insurance vs Universal Life can offer further insights.
- Variable Universal Life Insurance: Allows policyholders to invest the cash value in various investment options, which can lead to higher potential returns (or losses).
- Indexed Universal Life Insurance: The cash value’s growth is tied to a specific market index.
It’s essential to note that term life insurance does not offer a cash value feature.
How is Cash Value Formed?
In a cash-value life insurance plan, every premium you remit is bifurcated. One part is dedicated to life insurance coverage, while the other contributes to the cash value growth. This segment of your policy benefits from tax-deferred growth in interest. The manner in which this interest is generated is contingent on the specific variant of the permanent life insurance you opt for.
Accessing the Cash Value
One of the significant benefits of cash-value life insurance is the ability to access funds when needed. Policyholders can:
- Make a Withdrawal: You can take out a portion of the cash value, but this may reduce the death benefit. If your withdrawal exceeds the amount paid into the cash value, it’ll be taxed as income.
- Take a Loan: Borrow money against the policy’s cash value. If not repaid, the loan amount will reduce the death benefit.
- Surrender the Policy: Cancel the policy and receive the accumulated cash value. However, this means giving up the death benefit.
- Use Cash Value to Pay Premiums: If you’re short on cash, you may be able to use the cash value in your policy to help pay your life insurance policy’s premium. However, depleting the funds in the cash value account can cause your policy to lapse.
Benefits and Drawbacks of Cash Value Life Insurance
- Tax-Deferred Growth: The cash value grows tax-deferred, meaning you won’t pay taxes on the growth as long as the money remains in the policy.
- Flexible Premiums: Some policies allow flexible premium payments based on the cash value’s growth.
- Lifetime Coverage: Unlike term life insurance, whole life insurance with cash value provides coverage for life as long as premiums are paid. Life Insurance can also help cover unexpected expenses, such as funeral costs. To get an idea of potential costs, check out our guide on how much a funeral costs in Canada.
However, it’s also essential to be aware of the potential drawbacks:
- Higher Premiums: Cash-value life insurance policies typically come with higher premiums than term life insurance.
- Complexity: These policies can be more complex, requiring a deeper understanding of the terms and conditions.
Cash Value Life Insurance in the Canadian Context
In Canada, cash-value life insurance policies offer a unique blend of insurance and investment benefits. However, it’s crucial to consult with an insurance expert to determine if this type of policy aligns with your financial goals and needs.
The Canadian insurance landscape has seen remarkable growth and transformation over the years. As highlighted in the “Canadian Life & Health Insurance Facts – 2021 Edition”, life and health insurers in Canada managed retirement savings for a significant number of Canadians, totalling over 8 million. This showcases the trust Canadians place in insurance products for their retirement planning. Furthermore, the annuity payments, which are closely related to products like cash-value life insurance, have surged by over 40% in the past decade. The total premiums in the sector reached an impressive $123 billion in 2020. Such statistics underscore the importance of understanding and integrating products like cash-value life insurance into one’s comprehensive financial strategy, especially in the Canadian context.
Cash value life insurance offers Canadians an opportunity to combine protection and savings. While it comes with numerous benefits, weighing the pros and cons and consulting with professionals to make an informed decision is essential. For a different perspective, you might also be interested in exploring some reasons not to buy life insurance.