Cash value life insurance lasts your entire life and also includes an investment component — the cash value — that grows tax-deferred over the life of the policy. You can use the cash value to take out a loan, and, in some cases, pay your premiums. But cash value life insurance gains aren't as high as traditional investments and are only useful for people who have maxed out other investment accounts.
Cash value life insurance policies cost five to 15 times more than term life insurance for the same coverage amount.
Most people don't need a cash value life insurance policy, which is costly and complex to manage.
Cash value accounts usually come with limited investment options and relatively low rates of return.
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: You pay a premium to keep your policy active. When you die, your beneficiaries get the death benefit as a tax-free lump sum.
With a cash value life insurance policy, part of your premium also goes into the cash value of the policy. The exact amount is determined by your individual policy. The cash value account grows over time and can only be used while you are alive.
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How cash value grows
The money you put towards the cash value is subject to a low interest rate that helps it grow, though significant growth takes decades. But after those few decades, you may be able to double your dollar, which grows both the death benefit and the cash value. Check out this graph to get a sense of how your policy’s cash value and death benefit can grow over time:
Who should get cash value life insurance?
Though term life is sufficient for most people, a cash value life insurance policy may be useful 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.
How much does cash value life insurance cost?
The cost of life insurance, including cash value policies, is determined by five factors: policy type, health, age, hobbies, and gender. On top of that, cash value life insurance is five to 15 times more expensive than a comparable term life insurance policy, which makes it a costlier life insurance option.
Cash value life insurance costs more than term life for a few reasons:
It lasts longer: Cash value life insurance does not expire. Term life insurance is cheaper because it only lasts as long as the term length.
It has a cash value 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.
Pros and cons of cash value life insurance
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:
Coverage lasts your entire life.
You can use the cash value to take out a policy loan, pay for your policy's premiums, or withdraw the cash and surrender the policy.
The cash value can supplement your retirement income to your 401(k) or Roth IRA. It's still vulnerable to market fluctuations, but often has a guaranteed rate of return.
Cash value gains are tax-deferred. 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:
Most cash value growth happens takes decades.
Cash value life insurance policies have a high surrender rate because they can be too costly to maintain.
Cash value has limited investment options and relatively low rates of return compared to dedicated investment options, such as a 401(k) or IRA.
Many of the benefits of cash value are subject to taxes and fees.
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 not the right life insurance choice for most people. Getting a term life insurance policy and then investing the difference in traditional investment options will reap higher rewards.
Some individuals with a specific financial needs may consider cash value life insurance 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.
Frequently asked questions
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 earns interest.
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, and variable life insurance.
What happens to the cash value when you die?
The cash value usually goes back to the insurance company when you die. Any unpaid cash value loans are deducted from the death benefit. Some policies add the cash value to the death benefit when you die, but they're costlier.