Whole life insurance is a type of permanent life insurance that provides lifelong coverage, as long as you continue to pay the required premiums. One of its most distinctive features, and a key difference from term life insurance, is the cash value component.
What is Cash Value?
Cash value is a savings or investment component built into a whole life insurance policy. A portion of each premium payment you make is set aside and placed into this account, where it grows over time on a tax-deferred basis. This accumulation is guaranteed to grow at a fixed, minimum rate determined by the insurance company.
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Think of it as a two-part system:
The Death Benefit: The main purpose of the policy is to provide a guaranteed payout to your beneficiaries when you die.
The Cash Value: A separate account within the policy that you, the policyholder, can access and use during your lifetime.
How Does Cash Value Accumulate?
The accumulation of cash value is a gradual but predictable process.
Premium Allocation: A part of your premium covers the cost of the death benefit (the "cost of insurance"), while another portion goes into the cash value account. In the early years of the policy, a larger portion of your premium may go toward the cash value. Over time, as the cost of insuring you increases with age, a greater percentage of the premium will be allocated to the cost of insurance.
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Guaranteed Growth: The cash value grows at a guaranteed minimum interest rate. This makes it a very low-risk savings vehicle. The growth is tax-deferred, meaning you don't pay taxes on the interest or earnings as long as the money remains in the policy.
Dividends: If you purchase a whole life policy from a mutual insurance company, you may also receive dividends. These are not guaranteed, but when paid, they can further increase the cash value of your policy.
