Some life insurance policies double as investments because they earn you money. Your initial investment and increase in a policy’s worth is known as accumulated value. Depending on your goals, you can borrow against your accumulated value or cash it out early. Both of these actions might have tax implications.
Understanding the different types of life insurance policies available will help you decide which is best for you, based on your age, marital or parental status and retirement savings goals.
Read More: Alternatives to Life Insurance
What Is Accumulated Value?
Some life insurance policies only pay a benefit when you die. For example: a term life insurance policy. If the term of the policy expires before you die, then the insurance company keeps the premiums you pay and you receive nothing in return (other than the peace of mind of knowing you had life insurance for that time period). For this reason, the premiums are lower.
When you purchase an insurance policy that grows in worth, it accumulates value. The total of your initial investment plus any gains you’ve made represent your accumulated value at that point in time. Your accumulated value (also known as cash value) will change each time you pay your premium as your policy continues.
With this type of policy, you can borrow against the accumulated value because it’s an asset you own. You will also be able to cash out all or part of your accumulated value, paying taxes on it only when you do so because these policies are tax-deferred financial instruments. You might also have to pay a cash surrender value.
Read More: Whole Life Insurance Explained
Whole and Universal Life Insurance
The policies that accumulate value and earn you cash are the whole and universal life policies, known as permanent life insurance. Each time you pay a premium, you accumulate value. Part of your premium goes to covering your insurance policy, while another part of your premium payment goes to your cash accumulation.
When you are ready to borrow against or cash out all or part of your policy, such as whole life, insurance companies will discuss how you want to do this, if you want to repay part or all of the loan, how you want to handle interest, etc. They should also be able to explain to you the tax implications of cashing out or borrowing against your accumulated cash value.
Read More: What Does It Mean for an Insurance Policy to Mature?
Cash Surrender Value
When you cash out your policy, you might not get the total accumulated value you have earned, explains Nasdaq. For example, if you have accumulated $200,000 in value and want to cash out your policy, you might need to pay a cash surrender fee of $15,000. You’d only receive $185,000, therefore, when you cash out.
This payment depends on when you cash out – for example, if you do so before the end of your original policy contract. You can find out what your fees might be by reading your policy, or you can call your policy issuer for an explanation.
Steve Milano has written more than 1,000 pieces of personal finance and frugal living articles for dozens of websites, including Motley Fool, Zacks, Bankrate, Quickbooks, SmartyCents, Knew Money, Don't Waste Your Money and Credit Card Ideas, as well as his own websites.