Cash value life insurance

Cash value life insurance refers to any type of permanent life insurance that comes with an investment-style savings component, called the cash value.

When you shop for a life insurance policy, one of the first decisions you’ll need to make is whether to buy cash value life insurance (a type of permanent life insurance) or term life insurance

Cash value life insurance lasts your entire life and also includes a savings component. The cash value works like an investment or savings account and grows tax-deferred over the life of the policy. Any type of life insurance that offers this feature is considered cash value life insurance.

A policy’s cash value can be withdrawn, used to take out a loan, and, in some cases, used to pay the policy’s premiums. But cash value life insurance also comes with certain risks.

Term life insurance, on the other hand, is affordable and straightforward, which makes it the right choice for most people.

Key takeaways

  • Cash value life insurance, also known as permanent life insurance, doesn’t expire and comes with a tax-deferred savings component

  • Cash value life insurance policies typically cost 5 to 15 times more than term life insurance for the same death benefit amount

  • Because cash value life insurance is more expensive and more complicated than term life insurance, it isn’t recommended for most people

  • Cash value policies usually come with limited investment options and relatively low rates of return

What is cash value life insurance?

Cash value life insurance is a type of permanent life insurance and has an added savings component that acts as a forced tax-deferred savings vehicle. Because it offers permanent coverage, it lasts your entire life, which makes it more expensive than a comparable term life insurance policy.  

How does cash value life insurance work?

The death benefit of a cash value life insurance policy works the same way as it does with term life insurance: The policyholder pays either a monthly or annual premium to keep the policy active. If the policyholder dies, listed beneficiaries receive the death benefit, usually as a tax-free lump sum of money.

With a cash value life insurance policy, a certain percentage of your premium also goes into a tax-deferred savings component, known as the cash value of the policy. The exact amount that goes into savings is determined by your individual policy. The cash value account grows over time and can only be used while you are alive.

Types of cash value life insurance

There are several different types of cash value life insurance, and each accrues cash value differently. Here’s how a few of the most common types of policies work:

  • Whole life insurance cash value earns interest at a rate set by the life insurance company. Mutual insurance companies also pay dividends.

  • Universal life insurance cash value earns interest at a variable rate set by the life insurance company.

  • Variable life insurance cash value is invested in sub-accounts offered by insurers that work much like mutual funds. The performance of the cash value is based on the returns of those sub-accounts. Premiums remain level.

  • Variable universal life insurance cash value is invested in sub-accounts offered by insurers that work much like mutual funds. The performance of the cash value is based on the returns of those sub-accounts. Premiums can vary and are up to the policyholder.

  • Indexed universal life insurance cash value is invested in a stock market index (such as the S&P 500) selected by the insurer. Most policies have both an interest rate floor and ceiling, meaning that the cash value growth won’t go below or above a certain range.

  • Guaranteed universal life insurance has minimal to no cash value accumulation.

→ Check out our full explanation of the different types of life insurance

What are life insurance dividends?

When an insurance company’s investment portfolio is performing well, they share the profits with their policyholders. This is called a life insurance dividend . The way you earn dividends depends on your life insurance company. For mutual companies, the policyholders are considered the stockholder and may receive a higher dividend rate than those who are insured by publicly traded companies. 

Cash value policies are highly customized and how your dividends are paid out to you also depends on your needs and your insurer. Most policies pay out dividends to the cash value, but some people can get their dividends right away. As your cash value increases, you can use those dividends to pay your policy premiums. 

To ensure your cash value life insurance policy works the way you need it to, it’s vital to discuss your policy options with a financial professional. 

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Who should consider cash value life insurance?

Though term life is sufficient for most people, a cash value life insurance policy may be useful in a few scenarios.

The first consideration should always be whether or not you can afford the policy. Because cash value life insurance policies cost much more than a comparable term life insurance policy, many are dropped prematurely or don’t provide a proper level of coverage.

Cash value life insurance policies can make sense for people with complex financial needs, including:

  • High-income earners who have already maxed out their other retirement accounts and are seeking an additional vehicle for tax-deferred savings.

  • High-net-worth individuals who are looking to build a tax-free inheritance for their children or offset the costs of an estate tax on their assets.

  • People whose children have special needs or who have other lifelong dependents.

→ Learn how to buy life insurance

How much does cash value life insurance cost?

Compared to term life insurance, which is typically affordable, cash value life insurance can be expensive. Cash value life insurance policies, like whole life insurance, can be five to 15 times as expensive as a comparable term life insurance policy.

Cash value life insurance costs more than term life for a few reasons:

  • It lasts longer: Cash value life insurance is a type of permanent life insurance, so it does not expire. Term life insurance is cheaper because it only lasts as long as the term length.

  • It has a cash value component: As we previously mentioned, in addition to life insurance, you also get an investment-like component. With a cash value policy, your premium payments are split between the death benefit and the cash value, which leads to higher rates.

  • It has more fees: Similar to a traditional investment account, a cash value component means you have to pay management fees, which are incorporated into your premiums.

The cost of life insurance, including cash value policies, is determined by five factors: policy type, health, age, hobbies, and gender.

→ Learn more about the cost of life insurance

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Pros and cons of cash value life insurance

Cash value life insurance, like all life insurance policies, comes with its own set of pros and cons that are worth considering when you’re purchasing a life insurance policy. Cash value life insurance can open up loan and investment options, but it can also be prohibitively expensive to maintain and there are more lucrative ways to grow your savings.

Pros of cash value life insurance:

  • Life insurance coverage lasts your entire life. 

  • You can take out a policy loan against the cash value that has lower interest rates than other types of loans.

  • The cash value can pay for your policy's premiums once it has accumulated enough and you’ve owned the policy for at least a year. This can help prevent a policy surrender due to unpaid premiums.

  • Cash value life insurance can be a useful retirement income supplement to your 401(k) or Roth IRA. It's still vulnerable to market fluctuations, but usually has a guaranteed rate of return. You can access the cash value instead of dipping into your savings or IRA.

  • If you need the cash or no longer need life insurance, you can surrender the policy and take the cash.

  • Cash value gains are tax-deferred, much like gains from a 401(k). That means withdrawals less than or equal to what you’ve paid into the policy – the cash basis – are not taxable, but withdrawals greater than the cash basis are taxable.

Cons of cash value life insurance: 

  • It takes a long time to build up the cash value. Most of the growth happens after you’ve had the policy for two or three decades. So if you surrender it within the first 10 years, it’s unlikely that your cash value will be greater than the total premiums you have paid.

  • It's expensive. Cash value life insurance policies typically cost 5-15 times more than term life insurance for the same coverage amount.

  • There is a higher chance of policy surrender. According to one study, about 45% of people who purchase cash value insurance surrender their policies within the first 10 years due to high premiums.

  • The cash value isn't added to your death benefit. Your beneficiaries are guaranteed to receive the death benefit payout when you die, but you can only utilize the cash value component while you are living.

  • There are better ways to invest. Cash value has limited investment options and relatively low rates of return compared to dedicated investment options, such as a 401(k) or IRA.

  • Unpaid policy loans are taxable. Any unpaid loans (from a policy lapse or if you die before your loans are repaid) against your policy's cash value are taxed.

  • If you surrender your policy for the cash value, any profit you've made is subject to tax. And if you surrender the policy during the first two to three years, you likely won’t get any of the cash value, or you may be subject to high administrative fees.

  • If you deplete the entirety of the cash value to pay your premiums, your policy will lapse.

  • An overfunded cash value that exceeds the annual premium limit (set by the IRS) converts into a modified endowment contract (MEC). MECs are subject to additional taxes and penalties for withdrawals.

Is cash value life insurance worth it?

Because of cash value life insurance policies’ high cost, they’re usually not the best choice when it comes to life insurance. Most people would benefit more from getting a term life insurance policy and then investing the difference in traditional investment options.

A term life policy, which is meant to protect your dependents while they rely on your income, is sufficient for most people. That’s because as you age, your financial obligations – such as paying off a mortgage or supporting children – usually decrease and you don’t need life insurance coverage.

For some individuals with a unique set of circumstances, cash value life insurance could be a good policy option once they have maxed out all other investment vehicles. You should consult with a financial advisor or independent broker like Policygenius to determine the best life insurance option for you.

Cash value life insurance FAQs

What is the cash value of a life insurance policy?

A tax-deferred savings component. When you pay premiums for a cash value life insurance policy, a certain percentage goes into a cash value account, which can accumulate value over time like an IRA or 401(k) account.

What types of life insurance policies have cash value?

Most permanent life insurance policies have a cash value component, including whole life insurance, universal life insurance, variable life insurance, variable universal life insurance, indexed universal life insurance, and guaranteed universal life insurance.

What happens to the cash value when you die?

The cash value goes back to the insurance company when you die because it can only be used while you are alive. However, your beneficiaries still receive the death benefit payout. If you took out any loans against your policy’s cash value, any outstanding payments will be deducted from the death benefit.