One of the most utilized tools in funding an estate plan is term or permanent life insurance. Purchasing a life insurance policy gives an individual or couple the ability to transfer the financial risk of loss of income or the burden of estate taxes to an insurance company in exchange for paid-in premiums.
Life insurance carriers offer two main benefits to insured individuals when a transfer of risk occurs: death benefit proceeds and cash value savings. The death benefit is the amount payable to beneficiaries of the insured individual once the insured passes away, and the cash value balance is a forced savings component available to the insured while he is still living.
A death benefit is a tax-free payout to a beneficiary named by the insured after the insured has passed away; the benefit is payable provided that the policy is active and all premiums have been paid.
Permanent life insurance plans have a cash value savings component; the cash value is what’s left of the money paid in premiums after the cost of insurance and other fees have been deducted.
Cash value is available to the insured while they are alive; to access cash, they can choose to surrender part of the policy or take out a policy loan.
Whatever portion of the cash value has not been used at the time of the policyholder’s death is forfeited to the insurance company unless a rider has been purchased to allow it to be added to the death benefit.
A person typically purchases a life insurance policy to secure a death benefit made payable to the survivors of the insured once he is no longer living. Insurance companies offer a total death benefit for whatever amount is deemed appropriate by the insured as long as the policy is in force and premiums are paid. The insurance company pays the death benefit as a tax-free transfer to named beneficiaries once the carrier is made aware of the insured’s death, and the beneficiaries can use the funds without restriction.
The cash value of a permanent life insurance policy grows tax-deferred and could eventually be used by the policyholder to pay the monthly premiums.
With permanent life insurance policies such as whole life or universal life, insured individuals have the ability to accrue savings within the cash value of the policy. The cash value of a life insurance policy equals the total amount of premiums paid minus the cost of insurance and other charges assessed by the carrier. Cash value balances can also fluctuate based on the underlying investment in which the balance is allocated. Unlike the death benefit, cash value balances are available to the insured or owner of a life insurance policy while he is still alive, either through a partial surrender of the policy or by way of a policy loan. Any remaining cash value left once the insured dies is forfeited to the insurance company unless a specific rider has been purchased to allow for it to be added to the death benefit.
Martin A. Smith, CRPC(R), AIFA(R), RPS(R)
Wealthcare Financial Group, Inc., Bethesda, MD
The death benefit of a life insurance policy represents the face amount that will be paid out on a tax-free basis to the policy beneficiary when the insured person dies. Therefore, if you were to buy a policy with a $1 million dollar death benefit, your beneficiary will receive $1 million upon your death.
The cash value of the policy represents the portion of savings (or investments, depending on the type of policy that you own) that is funded by a portion of your insurance premiums. This cash value grows on a tax-deferred basis and could eventually be used to pay premiums; it can also be withdrawn tax-free as a loan. You would have to discuss doing so with your insurance carrier, though: if you withdraw too much, you might inadvertently cause the policy to lapse.