What is cash value life insurance?
The cash value of life insurance is the portion of a permanent life insurance policy that may experience tax-advantaged growth over time. The term “cash value life insurance” can refer to any life insurance policy that includes this feature. Unlike the death benefit, which your beneficiaries get when you die and assuming no rider allowing for the acceleration of the benefit, the cash value of your policy can be used while you’re alive.
How does your life insurance policy earn cash value?
Every time you make a premium payment, part of the money goes toward the cost of maintaining the policy, and part goes toward the cash value. The exact distribution depends on your individual life insurance policy.
In traditional whole life insurance policies, the cash value grows at a set low interest rate determined by the insurer. In other types of cash value life insurance, growth may be tied to a market index, dividends, or investment-style subaccounts offered through the insurer, depending on the policy.
Policy fees, cost of insurance charges, loans, withdrawals, and premium payment history can all affect cash value accumulation over time.
Example of cash value life insurance
Types of life insurance with cash value
Most types of permanent life insurance policies have a cash value component. Permanent policies last your entire life as long as you continue to pay the premiums. Below are a few of the main types of policies that have a cash value feature.
Whole life insurance is one of the most popular types of cash value policies. Its cash value grows at a fixed rate set by your insurer. Participating companies provide annual dividends which increases the rate of growth if used with paid up additions.
Universal life insurance is a more flexible type of permanent life insurance policy because you can increase or decrease how much you pay toward your premiums. Deviating from the original plan may impact policy performance. Cash values are often based on current assumptions stated annually by the carrier and not associated with an index or direct investment.
Variable universal life insurance allows you to base your cash value growth on various funds offered by the insurance company. You may earn more interest this way than you would with a whole life policy, but you take on much more risk. allows you to base your cash value growth on various funds offered by the insurance company. You may earn more interest this way than you would with a whole life policy, but you take on much more risk.
Indexed universal life insurance (IUL) is a type of universal life policy in which the cash value changes based on a market index.
Guaranteed issue life insurance is a type of whole life insurance policy that offers smaller coverage amounts meant to be used for end-of-life expenses, such as funeral costs. Many guaranteed issue policies have a cash value component, but it’s not the main purpose of the policy.
Pros of cash value life insurance
Coverage can last your entire life.
Cash value life insurance can be used to offset estate taxes if the policy ownership is handled correctly. This often involves an Irrevocable Life Insurance Trust to remove the death benefit from the gross estate. If your estate exceeds the federal estate tax exemption of $15 million, the life insurance death benefit can help cover the tax liability and preserve an inheritance for your beneficiaries. State estate tax exemptions vary.
Cash value gains are tax advantaged. Cash value life insurance can provide another tax-deferred growth vehicle with the additional benefit of potentially income tax free distributions. This is a valuable supplement if you’re already maximizing contributions to other accounts, like a 401(k) or Roth IRA.
Cons of cash value life insurance
It’s more expensive to transfer temporary risk. Cash value life insurance is much more expensive than a comparable term life insurance policy. If your primary goal is to put a financial safety net in place for your family during your prime earning years, other life insurance products — including term life insurance — can get the job done at a cheaper price.
Cash value can take time to build and may be costly to access early. Accumulating significant cash value can take years or even decades. Many policies impose surrender charges if you cancel the policy or access too much of its cash value during the surrender period, which can last nine to 18 years depending on the insurer’s schedule.
Policyholders may not see meaningful returns for approximately 20 years unless the policy is structured with a large, short-pay funding arrangement. It’s important to understand the surrender schedule and be confident that you can maintain the required premiums.
Cash value is not always paid to beneficiaries. With whole life insurance, the accumulated cash value typically remains with the insurance company when you die, while your beneficiaries receive the death benefit.
Some universal life insurance policies offer an increasing death benefit option that adds the accumulated cash value to the policy’s death benefit. However, this structure increases expenses by keeping the insurer’s net amount at risk higher. As insurance costs rise later in life, the additional charges could put the policy at risk if it isn’t adequately funded.
Other options could yield higher rates of return and more flexibility. Investing directly in the market allows you to control how much you put in at any given time.
What happens to cash value when you die?
One of the most common misunderstandings about cash value life insurance involves what happens to the accumulated cash value when the insured person dies.
In most cash value life insurance policies, beneficiaries receive the death benefit, not the cash value itself. The cash value typically remains with the insurance company unless the policy includes a specific rider or death benefit option that provides additional payouts.
Before purchasing a cash value policy, consider asking:
Will my beneficiaries receive only the death benefit?
Can the death benefit increase as cash value grows?
Are there death benefit options that include cash value?
How would loans or withdrawals affect the final payout?
Understanding these details can help you determine whether a particular permanent life insurance solution aligns with your long-term goals.
How to use the cash value from your life insurance
There are several different ways you’re able to use cash value, including:
Paying your premiums. Some insurance policies — like universal life insurance — allow you to use your cash value to pay premiums.
Take out a loan against the cash value. You may be able to borrow against your policy’s cash value. Policy loans accrue interest, and if the loan is not repaid, the outstanding balance and interest may be deducted from the death benefit or contribute to policy lapse.
Withdraw funds from your cash value. You can also withdraw money from your cash value. If you withdraw money without paying it back, it is typically subtracted from the final death benefit. Withdrawals can also have tax consequences if you withdraw more than your basis in the policy.
Surrender the policy for cash. If you no longer need the policy, you may be able to surrender it and receive the available cash surrender value, minus any fees or outstanding loans. Surrendering the policy ends your life insurance coverage. It may also create taxable income if the surrender value exceeds the amount you paid into the policy.
Is cash value life insurance right for you?
Cash value life insurance might be right for you if you have:
Permanent coverage needs, such as lifelong dependents
Complex estate planning goals
Maximized contributions to other tax-advantaged accounts
There are many different life insurance policies that include a cash value component, so it ultimately depends on the type of policy you purchase.
Since many cash value policies are significantly more expensive than other products, like term life insurance, many people choose to cover their financial obligations with a term life policy and then invest the difference separately.
This allows them to choose how much they invest, instead of being tied to a steep premium. Cash value life insurance policies often have high surrender rates because they’re expensive to maintain, so it’s important to think through cost before purchasing.
If you’re not sure which type of life insurance is best for you, a Policygenius expert can help you compare options from top insurers for free.
Other types of life insurance
Whole life vs. universal vs. guaranteed universal life insurance
Whole life insurance vs. indexed universal life insurance (IUL)
Cash value life insurance FAQs
Do term life insurance policies have cash value?
No. Term life insurance does not build cash value. It provides coverage for a specific period of time and pays a death benefit if the insured person dies during the term. Unlike term life, permanent policies may build cash value over time.
Can I withdraw cash value from life insurance?
Yes, depending on the policy. Many forms of cash value life insurance allow withdrawals. However, withdrawals can reduce the death benefit and may create tax consequences if they exceed the amount you paid into the policy.
Do beneficiaries receive the cash value when I die?
Usually, no. Beneficiaries generally receive the death benefit, while the cash value remains with the insurer unless the policy includes a rider or death benefit option that provides access to both.
What happens if I surrender a cash value life insurance policy?
If you surrender a cash value life insurance policy, you receive the available cash surrender value after fees, charges, or loans are deducted. Your coverage ends, and you may owe taxes if the surrender value exceeds the amount you paid into the policy.
Which types of life insurance build cash value?
Several forms of permanent coverage build cash value, including universal life insurance, variable life insurance, variable life, indexed universal life insurance, and other forms of indexed universal life products. The way cash value grows depends on the policy design and the options available through the insurer.
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