There are a lot of questions when it comes to cash value life insurance … What is cash value life insurance? What are its benefits? How can it help your organization retain top talent?
Let’s answer all of these questions below, starting with what cash value life insurance is.
What is Cash Value Life Insurance?
Cash value life insurance is permanent coverage—insurance that is designed to last for the insured’s lifetime—that includes a tax-favored investment account that the policyholder can use while the insured is still alive.
With all life insurance policies, there is still a large benefit paid to the beneficiaries when the insured dies.
But the cash value component can have tremendous value as well. It’s available to the policyholder while the insured is alive, and grows tax-deferred.
The cash value can be used to offset future premiums and/or accessed tax-free, for any reason, using either policy loans or a withdrawal of the principal. This component adds flexibility and provides a tax-favored source of income for retirement, travel, healthcare needs, or emergencies.
Which Life Insurance Plans Offer Cash Value Components?
The following types of permanent life insurance policies may include a cash value feature:
- Whole life insurance
- Universal life insurance
- Indexed universal life insurance
- Variable universal life insurance
Term life insurance—which is life insurance for a period of years—does not offer the cash value feature. Rather term life insurance only has two components: the premium that’s due and the death benefit.
Read on to learn more about the differences between term life insurance and permanent life insurance.
How Does Cash Value Life Insurance Help Retain Top Talent?
So, how does cash value life insurance help retain top talent?
First, a plan needs to be created using a legal agreement, then “funded” with permanent life insurance. Whether the policy is owned by the employer or the key employee depends on the situation.
The agreement outlines the employee’s obligations, typically tied to longevity and performance, that will trigger the payment of a meaningful retirement income over a period of years (for example, 75% of average salary paid each year from age 66 to 80).
This can help incentivize top talent to stay for a longer period of time and perform. If they do, they’ll receive a retirement benefit and if they don’t, they typically won’t receive anything.
Using Cash Value During Life
Cash value life insurance is the preferred method of funding these agreements. First, the cash value grows tax-deferred and serves as the source of the retirement income that is eventually paid to the key employee. Many policies offer competitive cash value yields without risk of loss or direct market exposure.
If the executive passes away unexpectedly, the death benefit is used to replace the projected income stream for his/her family that the executive would have received in retirement. The organization may also be entitled to a portion of the death benefit to compensate for the cost of losing and replacing the key person.
Offering a stream of income in retirement is a powerful retention tool, but the “self-completing” feature that life insurance death benefit provides can be so meaningful to the executive’s family that it can make it almost impossible for the executive to leave.
It’s important to note that the organization could fund the plan with something other than life insurance, such as mutual funds, stocks, and/or bonds. However, these investments are taxable every year whereas the growth of the life insurance cash value is tax-deferred.
In addition, there is typically a risk of loss with these investments and they do not offer a self-completing feature like the life insurance death benefit. Lastly, life insurance carriers are some of the oldest and strongest companies in the world and can be trusted with these important assets.
Funding Executive Retention and Executive Retirement Programs
Funding these plans isn’t free, so having a mechanism in place to offset costs can make approval by the organization’s decision-makers easier.
In contrast to the policy used to fund the executive retention and retirement plan, above, our firm also uses a special life insurance-based program that allows organizations to earn 2.5-to-6.0% currently on their cash assets, without sacrificing safety or liquidity.
If these funds are currently earning 1.0-to-2.0% in the bank, CDs, or short-term bonds, the organization can shift them to the life insurance-based program and use the “found” earnings to fund the executive retention plan.
Using life insurance as a mechanism to fund executive retention and retirement plans, and as a way to offset the costs of such plans, can make these arrangements truly a win-win for the executives, their families, and the organization.
Learn More on Our Blog
Interested in learning more? Read on to learn about the benefits of credit union-owned life insurance, why a credit union should invest in credit union-owned life insurance, or what permanent life insurance options are available to you, including information on how cash value grows in each plan type.
*Important Notes: Please refer to 26 U.S. Code §101(a) regarding tax-fee death benefit and 26 U.S. Code § 7702 (a) (g) regarding tax treatment of cash value. Policy performance is based on current rates as charges, and some values are not guaranteed. Medical and financial underwriting is required. Withdrawals and loans from life insurance policies classified as Modified Endowment Contracts (MEC) may be subject to income tax and a federal tax penalty, if taken prior to age 59½. Excessive policy withdrawals and loans may cause the policy to lapse, which will result in the loss of death benefit and adverse tax consequences. Life insurance is backed by the claims-paying ability of the carrier and is not FDIC insured. See policy illustration for details. Acumen Insurance Solutions, LLC does not provide tax, legal, or investment advice, and is not FINRA registered.