Universal life insurance is a form of permanent life insurance that combines lifelong coverage with a cash value component. This cash value can grow on a tax-deferred basis and be used in various ways during your lifetime. But what happens to any remaining cash value when the policyowner passes away?
When you die, the cash value in a universal life insurance policy generally reverts back to the insurance company. It does not get paid out to beneficiaries along with the death benefit. Understanding how this works can help you make the most of the policy’s cash value while you’re alive.
Overview of Universal Life Insurance
Before diving into the cash value payout details, let’s first go over some universal life insurance basics:
Lifelong coverage – Universal life provides lifelong death benefit protection, assuming you continue to make the required premium payments.
Flexible premiums – You have flexibility to adjust your premium payments within certain limits, based on your changing budget.
Cash value – Part of each premium goes toward building up a cash value, which earns interest.
Adjustable death benefit – The death benefit can potentially be changed (increased or decreased) after issue.
Policy loans – You can take out loans using your cash value as collateral, allowing access to cash.
Withdrawals – Withdrawals can be made from accumulated cash value and are tax-free up to your cost basis.
Lapsing – If the cash value falls too low, the policy can lapse (terminate) if you don’t pay additional premiums.
The cash value portion makes universal life policies more complex than basic term life insurance. But it provides options to use the accumulating money during your lifetime if needed.
Now let’s look at what happens to any of the policy’s cash value that you haven’t utilized by the time of your death.
Cash Value Reverts to the Insurer at Death
When the insured person passes away, the named beneficiaries will receive the death benefit payout. But the cash value itself does not get paid out to beneficiaries—it reverts back to the insurance company.
- Your universal life policy has a $500,000 death benefit
- The current cash value is $100,000
- When you pass away, your beneficiaries will receive $500,000 (the death benefit amount)
- The $100,000 cash value will go back to the insurer and not get paid out
Some key things to understand:
- Cash value in life insurance is intended for policyowner use while alive
- It is not an additional payout to beneficiaries at death
- Any loans and unpaid interest reduce the death benefit
- Surrendering the policy returns the cash value but ends coverage
While cash value offers useful options during your lifetime, don’t count on it passing to heirs at death. Beneficiaries only receive the death benefit amount listed in the policy.
Exceptions: When Cash Value Pays Out
In some cases, cash value may pay out upon the policyowner’s death:
Included in death benefit – Some universal life policies allow you to structure the death benefit to include cash value. But this feature comes at a cost through higher premiums.
Spousal continuation – If a surviving spouse continues the policy, they may have access to the cash value.
Estate payout – Any cash value not used during your lifetime would become part of your overall estate value upon death. After debts and taxes are paid, heirs may receive a portion.
** Corporate policies** – Policies owned by a business may have differing rules on cash value payout at the death of an insured employee.
But in general, cash value works differently than a savings or investment account that automatically pays out to heirs. Take full advantage of the cash value options while you’re alive, as leftover amounts will revert to the insurer when you pass away.
How Does Cash Value in Universal Life Work?
Cash value in universal life insurance policies grows on a tax-deferred basis. Here’s an overview of how it works:
You pay premiums into the policy over time
A portion of each premium goes toward the cost of insurance
The rest goes into the policy’s cash value and earns a guaranteed minimum interest rate
The cash value accumulates tax-free as long as the policy is in force
You can use policy loans and withdrawals to access cash when needed
If unused, the cash value eventually transfers back to the insurer when you die
Cash value acts differently than money you contribute to a retirement account or investment:
- It’s not invested in the market, so returns are limited
- Accessing cash value reduces the death benefit
- It has no beneficiary payout at death beyond the base death benefit
If maximizing lifelong insurance protection is your priority, a guaranteed universal life policy may be preferable to other types that emphasize cash value growth.
How Does Cash Value Affect My Heirs and Estate?
Since cash value doesn’t pay out to beneficiaries at death, it does not directly benefit your heirs or increase the value of the death benefit they receive. Any cash value returning to the insurer at death bypasses your loved ones.
However, unused cash value would become part of your taxable estate. After any debts and taxes are settled, the remainder goes to beneficiaries according to your will or the estate laws in your state. Heirs may benefit from leftover cash value indirectly in this way.
And keep in mind, loans and accrued interest on cash value will reduce the net death benefit received by beneficiaries. For example:
- Your policy has a $500,000 death benefit
- You took out $50,000 in loans with $5,000 interest owed
- At death, the amount paid to beneficiaries is $500,000 minus $55,000 = $445,000
Managing loans and accessing cash value wisely helps ensure you don’t inadvertently shrink the death benefit left for heirs.
Options for Using Cash Value During Your Lifetime
Rather than leaving cash accumulation in a life insurance policy untouched, many financial experts recommend using it during your life in smart ways:
Withdraw money – Withdrawals allow you to take cash out of a policy without penalties or taxes (up to your cost basis). This reduces cash value.
Policy loans – You can access cash value via policy loans using the money as collateral. Loans reduce the death benefit.
Pay premiums – Once cash value reaches a certain level, you may be able to use it to pay your policy premiums.
Increase death benefit – Some policies allow you to use cash value to purchase a higher death benefit.
Exchange options – You may be able to use built-up cash value toward a new policy, such as exchanging to a lower-cost guaranteed universal life policy.
Work with your insurance advisor to develop a strategy for optimizing your policy’s cash value while you’re here to benefit from it.
What Happens if You Surrender the Policy?
Surrendering a life insurance policy means cancelling it and getting cash in return. The amount paid to you if you surrender a universal life insurance policy is called the cash surrender value.
The cash surrender value will typically be equal to the accumulated cash value, minus any surrender fees outlined in the policy. Surrendering ends the life insurance coverage permanently.
Here’s an example of how surrendering a policy works:
- Your policy has a cash value of $100,000
- Surrender fees in your policy are 10% of cash value
- You receive the $100,000 cash value minus $10,000 surrender fee = $90,000 cash payout
- Your life insurance coverage terminates
If you surrender while in good health, you may be able to purchase a new policy. But it often makes more sense to withdraw money or take loans rather than forfeiting coverage completely.
Tapping Cash Value Through Withdrawals and Loans
Withdrawals and loans allow you to access cash value without losing your insurance coverage. Here’s an overview:
- Allows you to take money out of accrued cash value
- Reduces the policy’s cash value
- No fees or income tax (up to your cost basis)
- Doesn’t require payback; cash is removed permanently
- Uses the cash value as collateral for a loan from the insurer
- Reduces the death benefit by the loan balance
- Interest charges apply; if unpaid, interest is deducted from benefit payout
- Loans can be repaid, or taken continuously with interest accruing
With withdrawals, the cash comes directly out of the policy. With loans, you’re temporarily borrowing against yourself and have the option to repay.
Both can provide access to cash value during the policyholder’s lifetime without surrendering the coverage.
Avoiding an Unintended Policy Lapse
One risk with universal life insurance is that over time, the costs and fees can drain the cash value if it’s not growing fast enough. If the cash value falls below a minimum required amount, the policy can lapse.
To prevent an unexpected lapse, pay close attention
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