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How Does Cash Value in a Life Insurance Policy Really Work?
Whenyou own cash value life insurance, your premium payments are allocated threeways. First, a portion of each premium pays for the actual insurance costs. Like term insurance, a specific cost is associated with the policy's deathbenefit, based on your age, health, and other underwriting criteria. Second, aportion pays for the insurance company's operating costs and profits. Theremainder goes toward the policy's cash value. What is cash value? Terminsurance charges an increasing premium (annually or in bands) to reflect thefact that the insured is aging and, each year, more likely to die. Cash valuelife insurance has a level premium that is larger than necessary in the earlyyears of the policy to offset the increased costs of insuring the individual inthe later years. This excess premium is invested and kept in an account knownas the cash value account. In the event that you surrender the policy beforedeath, this excess premium and its earnings are returned to you. Cash value,[link widoczny dla zalogowanych], by any other name... Sincecash value life insurance, also known as permanent life insurance, comes inmany product varieties, people often get confused. Whole life, variable life, universal life, and variable universal life are among the most common cashvalue life insurance products found in [link widoczny dla zalogowanych]ay's marketplace. All of thesepolicies operate in much the same fashion. For the purposes of this discussion, where they differ is in how the cash value is invested. How cash value growsWe'vealready said that a portion of every premium payment goes toward your policy'scash value. So, it's easy to understand that the cash value of a policy willgrow as additional premiums are made. The cash value of a policy may also growbecause of earnings. Wholelife policies offer "guaranteed" cash value accounts that increasebased on a formula determined by the insurance company. (Guarantees are subjectto the claims-paying ability of the insurer. ) Universal life policies offercash value accounts that track current interest rates. Variable life policiesallow their owners to invest in accounts that operate like mutual funds,[link widoczny dla zalogowanych], meaning that their cash value accounts can be invested in bond, stock, andother funds,[link widoczny dla zalogowanych], known as subaccounts. The cash value will grow or decline based onthe performance of the underlying subaccounts. The amount of your premium that goes toward cash value decreases overtimeOvertime, the amount that you contribute from each premium toward cash valuedecreases,[link widoczny dla zalogowanych], because the cost of insuring you increases every year. The patternis similar to what happens with a mortgage. In the early years of a home loan, you pay mostly interest; in the later years, you pay mostly principal. Let'stake a very simplified example and assume you're paying a $25-per-month premiumfor cash value insurance. In the early years of the policy, it costs relativelylittle to insure you--say $5 a month--because your odds of dying prematurelyare low. In the later years of the policy, the cost to insure you is muchgreater--say $20 a month--because the insurance company knows that the odds aremuch greater that you will die as you grow older. Thecash value part of your premium behaves just the opposite of the insurancecomponent. In the early years of the policy, your cash value can grow quicklysince more of your premium is available for cash value. In the later years, thecost of insurance consumes more of your premium, so less is left over for cashvalue. The role of cash valueYouprobably understand that, as you grow older, the cost of insuring your lifegets more expensive. That's why a term insurance policy will generally cost youa great deal more at age 50 than at age 30. With cash value insurance, theinsurance company looks ahead and factors in the increasing costs of insuringyou as you grow older. The insurance company calculates a premium amount thatwill cover the anticipated increase in insuring your life. Cash value plays acentral role in this calculation. Asthe cash value of your policy grows, the amount that the insurance companyneeds to pay out as a pure death benefit decreases. That's because part of thepolicy payout upon your death comes from the cash value of the policy. Thelarger the cash value, the greater the percentage of the policy that can comefrom the cash value. In effect, to avoid increasing premiums as you get older, you're setting aside funds now to make up the difference. An exampleAlthoughgrossly oversimplified, cash value works something like this: Assumethat a policy will pay $1 million upon your death. You make monthly premiumpayments, and each month a portion of your premium is applied to the cash valueof the policy. After 30 years, the cash value of the policy is equal to$500, 000. Since the policy will pay $1 million upon your death, and the policyalready has a cash value of $500, 000, the insurance cost needs to cover onlythe remaining $500, 000. Tenyears later, the cash value is equal to $750, 000. Because you're 40 years olderthan you were when you bought the policy, the pure insurance cost of insuringyour life is significantly higher now. However, because of the cash value, yourpolicy is really insuring only $250, 000. The rest of your policy's payout willcome from cash value. Written byPermanent Life Insurance | Term vs Whole Life Insurance: BeamaLife.Topics related articles：

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