What is cash value life insurance? Full guide 2023
Cash value life insurance not only offers life coverage but also includes a unique feature: it builds a cash reserve over time.
This reserve acts like a savings account within the policy, and policyholders have the flexibility to access or borrow against this accumulated cash, providing both insurance protection and a financial resource.
But how does it work? When you can access the cash value? How is it calculated and what are its tax implications? For all this and more, here is our guide. Once you're aware, explore the best cash value life insurance Canada policies, compare them, and get free quotes using our comparator right here.
Cash value life insurance: 6 key takeaways
- Cash value life insurance combines coverage with a cash savings component.
- Policyholders can borrow against their cash value at lower interest rates.
- Pros: Permanent coverage, tax-advantaged withdrawals.
- Cons: Higher premiums, reduced death benefit.
- Types include whole life, universal life, and guaranteed issue options.
- Cash value withdrawals are tax-free, but interest and gains may be taxed.
What is cash value life insurance?
Cash value life insurance, also known as whole life insurance, combines life insurance coverage with a savings component. In Canada, when you pay your premium, a portion covers insurance costs, and the rest is invested, building a cash value account that grows over time.
This cash value can be accessed through tax-free withdrawals or loans, providing financial flexibility for various needs. For example, you can withdraw money for unexpected expenses or borrow against it for specific purposes, all while maintaining the life insurance coverage the policy offers.
If you're already aware of how this works, you can use our comparator below to access the best cash value life insurance Canada policies in the market, compare them, and get free quotes right here in seconds.
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How does life insurance cash surrender value work?
A portion of the money you pay in premiums goes towards building cash value. This money can be withdrawn or borrowed against. You are not restricted in how you use the money. When you end the policy you can withdraw the full cash value.
There is typically a surrender charge if you terminate the policy within the first two years.
Once you have built up your cash value levels sufficiently you may have the option to pay your premiums with it. You should note, however, that if you spend the whole cash value then the policy may become void.
What are the pros and cons?
Cash value life insurance can be a great way to invest money that you can withdraw without paying tax on it. It can also be used as an asset to secure a loan. However, there are ways in which traditional term life insurance could be better. Let's take a look at the advantages and disadvantages.
- Gives security of permanent life insurance
- An asset you can use as security
- Withdrawals are tax-advantaged
- Higher premiums than other forms of life insurance
- Cash withdrawals reduce the death benefit
- Loans secured by the policy will be paid out of the death benefit
Is cash surrender value of life insurance taxable in Canada?
Money borrowed or withdrawn from a cash value life insurance policy is not taxable. However, if you miss a payment on your premiums, the difference between the money borrowed and the money paid in can be taxed.
Any dividends, interest earned, or capital gains earned will be taxed. This is relevant if you have a life insurance policy where the cash value is tied to an index fund or is being invested for you.
We can summarize it this way: if you are using the policy primarily as life insurance, with a bonus or easily borrowable assets, you will not pay tax. If you are using the cash value life insurance policy as an investment vehicle then you will have to pay tax.
How to borrow against your cash value life insurance Canada plan?
Insurers charge an interest rate of around 6% to borrow against the cash value of a life insurance policy you hold with them. This is cheaper than the interest rate offered by most banks. Some insurers will let you borrow as much as 95% of the cash value of your life insurance.
There are great advantages to borrowing against your cash value:
- Borrowing against your cash value does not affect your credit score
- There is no credit check that you have to pass
- The loan is tax-free
- There are no terms or limits on repayment
- If you do not pay it back, the insurer will repay themselves from your death benefit
For these reasons borrowing against your life insurance can seem like a great option in a crisis. A wise move would be to speak to your insurance company and ask how borrowing the money would affect your policy with them.
What types of life insurance have cash value options?
Cash value is an option for several different types of permanent life insurance, however different policies generate different amounts of cash value and invest it in different ways. Let's take a look at which life insurance policies have cash value options.
Whole life insurance
Whole life insurance is a type of permanent life insurance. The policyholder agrees to pay a fixed premium in return for being covered for the rest of their life. The cash value interest rate is guaranteed in the policy and the policyholder does not need to make decisions about investing.
|Whole life insurance|
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Universal life insurance
Universal life insurance is a type of permanent insurance: it protects you for the rest of your life. These policies often have cash value options, allowing you to withdraw early from your policy. There are different types of universal life insurance policies, compare the features of different policies in the table below.
|Policy||Premiums||Risk||How is cash value grown?|
|Guaranteed universal life insurance||The cheapest option||Low||Savings level interest rates|
|Indexed universal life insurance||Flexible||Mid||Investment tied to an indexed fund|
|Variable universal life insurance||Flexible||High||Invested in stocks and bonds|
Whole life insurance calculator cash value
Guaranteed issue life insurance
The coverage is usually limited well below the level of other policies and the death benefit is also limited. The cash value option will also likely be small, and the amounts the policyholder can withdraw are minimal.
The death benefit will be reduced if the purchaser dies within a period agreed in the contract, typically the first few years after signing. This type of insurance is aimed mainly at people who want to avoid putting the responsibility of their funeral costs onto their dependents.
Is it a good idea to take the cash surrender value?
Cash value is a great resource in an emergency or to pay for something unexpected. The lack of a credit check or set repayment limits allows for flexibility that traditional loans cannot provide. That said, cash value life insurance is neither as cheap as term life insurance nor as effective a way to invest as ETFs or RRSPs.
Cash value takes a long time to build up. For the first few years of paying your premium the amount that you can borrow will be minimal. As a way of investing, a cash-value life insurance policy is disadvantaged as not all of your premium is invested. Part of it goes towards purchasing life insurance. This means that less money is invested and returns will be lower.
Another disadvantage is that withdrawing your cash value can lead to the termination of the policy, leaving you without life insurance. Therefore cash value life insurance only makes sense as a way to invest if you have already maxed out other options.
You can see for yourself and decide if a cash value life insurance policy is for you right here using our comparator below. Compare plans from the best Canadian providers and get free quotes in seconds.
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What are the best alternatives to a cash value life insurance Canada plan?
- Term Life Insurance: Term life insurance offers straightforward coverage for a specific period, typically at a lower cost than cash value policies. It's a good choice for those who want pure protection for a set term.
- Investing in Tax-Advantaged Accounts: Consider contributing to tax-advantaged accounts like Tax-Free Savings Accounts (TFSA) and Registered Retirement Savings Plans (RRSPs) for long-term savings and tax benefits.
- High-Yield Savings or Investment Accounts: Instead of the savings component of cash value insurance, you can put money into high-yield savings accounts or invest in stocks, bonds, or mutual funds for potential growth and flexibility without insurance fees.