In life insurance there are two concepts that can be a bit complex, but it is necessary to know how to differentiate. These are the concepts of cash value and face value, which make up permanent life insurance.
Whole life policies and universal life policies are considered permanent life insurance, since they provide coverage for the entire life of the insured.
Both cash value and face value are different in terms of how their amounts are determined. However, both the cash value and the face value can increase or decrease the amount to be paid to the beneficiary after the death of the insured.
Definition of nominal value and effective value
Face value is the amount the policy or life insurance beneficiary receives when the insured dies. It is a fixed and known amount from the beginning of the life insurance contract that does not depend on the years that the event takes to occur.
The cash value is the amount that is paid to you for the life insurance policy in the event that the insurance ends or is canceled before the event for which it was purchased occurs.
By their nature, the concepts of face value and cash value can only be differentiated in permanent life insurance, either whole life or universal life, since term life insurance has no cash value. In term life insurance, when the expiration term arrives when it is renewed for a longer term or another life insurance is purchased from a different insurer, the insured is not entitled to a cash value.
Cash Value Benefits
One of the advantages of cash value is that it is not tax deferred; that is, there are no tax consequences until the funds are withdrawn. This means that if the insured decides to access the funds through a policy loan, the money will be received tax-free and does not have to be repaid.
Another advantage is for the beneficiaries of the policy, who can obtain a larger sum at the death of the insured if the policy has additional options associated with it or if there are no funds in the cash value account.
However, it must be taken into account that, although the policy loan does not have to be repaid, if it is exceptional at the time of death, the nominal value of what the beneficiaries will collect could be reduced to that amount.
Differences when collecting the cash value in universal life and whole life insurance
Whole life policies pay cash value plus face value after the insured’s death.
However, beneficiaries of universal life insurance can collect in two different ways:
- Option A. The cash value is not paid, but is used to pay the final death benefit. The more money there is in the cash value account, the less money the insurer will have to pay life insurance beneficiaries upon the death of the insured. For example, if an insured has a universal life insurance policy of €70,000, with €30,000 available in the cash value account, the beneficiaries would receive €70,000 upon their death, of which €30,000 will be in the cash value account and €40,000 the insurer would pay.
- Option B. As with whole life policies, option B pays cash value plus face value after the insured’s death. In this case, with a €70,000 life insurance policy with €30,000 in cash value, the insured can elect to have the cash value added to the face value, which would result in a €100,000 death benefit for the insured.
Most people tend to opt for option A because, although this option brings lower benefits to insurance beneficiaries than option B, the premiums that have to be paid are also lower.
What is whole life insurance and how does it work?
Whole life insurance is a permanent insurance policy guaranteed to remain in force for the life of the insured as long as premiums are paid. When you first apply for coverage, you agree to a contract in which the insurance company promises to pay your beneficiary a certain amount of money, called a death benefit, when you die. You will choose your coverage amount and your premium based on several factors such as your age, gender and health status. As long as you pay your premiums, your life insurance policy will remain in force and your premiums will not change, even if your health or age changes.
For example, let’s say you buy a whole life insurance policy at age 40. When you buy the policy, the premiums will not change during the life of the policy as long as you pay them. They will be higher than the premiums for a term life insurance policy because your entire useful life is built into the calculation.
Unlike term insurance, whole life policies do not expire. The policy will remain in effect until your death or until you cancel it.
Over time, the premiums you pay on the policy begin to build cash value that can be used under certain conditions. The cash value can be withdrawn as a loan or used to cover your insurance premiums. All loans must be paid before you die or they will be deducted from the policy’s death benefit.
How Does the Cash Value Benefit Work?
Whole life policies are one of the few life insurance plans that build cash value. Cash value is generated when premiums are paid: the more premiums have been paid, the higher the cash value. The main benefit of cash value is that it can be withdrawn in the form of a policy loan.
For example, if you’ve been paying premiums for many years and have an unexpected medical bill or financial obligation, you can call your insurance company and see how much you can withdraw from your policy. As long as the loan and interest are repaid, the full amount of your policy coverage will be paid to your beneficiary. If the loan is not repaid, the death benefit will be reduced by the outstanding balance of the loan.
