What Happens to the Cash Value in Your Policy When You Die?
When a policyholder dies, the cash value within their life insurance policy has specific implications that many may not be aware of. Understanding how these funds are distributed and how they interact with the death benefit is crucial for both policyholders and beneficiaries.
The Cash Value vs. Death Benefit
When a policyholder passes away, the first order of business is the payment of the death benefit. This amount is typically much greater than the cash value and goes directly to the designated beneficiary named in the policy. Essentially, you do not receive both the death benefit and the cash value. The death benefit is paid out to the beneficiary, and the cash value stays with the insurance company.
This is important to note because the death benefit is always higher than the cash value. The cash value is essentially a savings component of the policy that accrues over time. It is used to offset the increasing premium costs or provide liquidity if needed, but upon the death of the insured, the primary purpose of the policy is to fulfill the death benefit to the named beneficiary.
Permanent Life Insurance and Cash Value
Permanent life insurance, unlike term life insurance, has a cash value that builds up over time. This cash value is a key advantage of permanent life insurance, as it can be used to pay off the premium or provide additional financial security. As years pass, the cash value continues to grow, potentially increasing the death benefit.
In non-restricted traditional life insurance policies, the full death benefit is paid out upon the insured's death, unless the death is by suicide within the first two years. Even if the cash value is much smaller than the death benefit, the full death benefit is still provided to the beneficiary. The cash value, on the other hand, is retained by the insurance company.
The primary purpose of the cash value is to ensure that the policy remains in force indefinitely. The death benefit is the primary payout, and once fulfilled, the policy contract ceases to have any further value.
How Your Beneficiaries Receive Money
Contrary to what competitors might claim, your beneficiaries do not keep the cash value as general advice suggests. Rather, your beneficiaries receive the death benefit, which includes both the death amount and the equity represented by the cash value. Your level premiums often include more than what is needed for basic coverage, and the overpayment initially goes towards building the cash value equity. As the years progress, the cash value increases, eventually contributing to the overall death benefit.
In the case of whole life insurance, a form of permanent life insurance, the insurance company charges a level premium that is structured to build cash value over time. This overpayment in the early years helps build up the equity in the policy. As a result, the total of the premium and the cash value equals the death benefit. The insurance portion is the death benefit, and the cash value is a return to the beneficiary.
Whole life insurance can be particularly advantageous. Due to the earning power of the equity, the policy can become profitable and potentially lead to a paid-up policy long before the age of 65. For some individuals, multiple whole life insurance policies can even provide a source of tax-free pension income. My acquaintance, for example, has managed to amass substantial tax-free income from ten whole life insurance policies, having long ago recouped three times the amount of all premiums paid.
The Final Disposition of Assets
While the primary concern is the distribution of the death benefit and cash value, it is also important to understand what happens to any remaining assets. Generally, if the deceased did not leave a directive (such as a will or testament) specifying how the assets should be distributed, the items typically go to the deceased's estate. If there are heirs, the government does not automatically receive the assets. However, without a will, the distribution process can become complex and subject to state and federal laws.
For those without specific directives, the assets are often distributed according to intestate succession laws, which vary by state. In such cases, the government or legal system may step in to ensure the proper distribution of the estate.
Understanding the implications of cash values and death benefits in life insurance policies is essential for making informed decisions about these financial instruments. Always consult with a trusted financial advisor to understand the nuances of how these funds are handled after your passing.
Keywords: cash value, permanent life insurance, death benefit