Cash Value Insurance Basics
Ownership of a cash value life insurance policy means that your premium payments are allocated a variety of different ways. First, in each premium payment, a portion of it goes towards paying the actual cost of the insurance. In all insurance there is a specific amount of money that is associated with maintaining the policies death benefit, which is based on your age. The second portion of the premium payment goes towards paying for the insurance company\’s operating costs and profits. The rest of the payment goes toward the cash value of the insurance policy.
How does my cash value grow
As I stated before, there is a portion of the policy premium that goes toward the cash value of the policy. Based on this theory, as additional premium payments are made, the cash value of the account will increase. Cash values can also grow simply based on the earnings.
Every type of cash value insurance policy offers different formulas on how to calculate the cash values. Whole life (or permanent insurance) offers a \”guaranteed\” cash value. This formula us determined by the insurance company and could vary slightly from company to company. Generally speaking though, the formula is based on the claims paying ability of the insurer. Universal life policies offer cash value accounts that follow the current interest rate values. Variable life policies allow the policy owner to choose between various sub-accounts such as stocks, bonds or other funds. As is true with other investments, the cash value in your Variable Life policy could fluctuate up or down based on the investment performance.
The cash value portion of your premium account decreases over time
Over time, the amount that you contribute from each premium toward cash value decreases, because the cost of insuring you increases every year. The pattern is 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.
As an example, assume if you will that you are paying a $25 per month premium. Throughout the early years of the policy, the cost of the insurance is relatively low, because you are less likely to die prematurely. As you grow older, the chances are increasing every year that you will die, therefore the cost of insurance is also increasing.
The relationship between the cash value and the insurance components work opposite each other. The cash value tends to grow faster in early years since most of the premium payment is available to build the cash value. As you get older, the cost of the insurance consumes a lot of those premiums.
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