What Is Cash Value Life Insurance?

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Updated: June 26, 2024

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A cash value life insurance policy integrates a savings component with life coverage, offering a financial cushion that grows over time. This feature is prevalent in specific policies, specifically permanent life insurance.

As the cash value in permanent life insurance accrues interest, it enhances the policy's net worth and offers a source of funds that the policy owner can borrow against. A cash value life insurance policy can be an excellent choice for individuals looking for long-term financial planning tools. It not only offers protection but also aids in wealth accumulation, presenting a valuable option for consumers focused on both security and investment growth.

Key Takeaways

Cash value life insurance is a permanent policy that earns money and provides a death benefit to the beneficiary.

Whole life and universal life are the two main types of life insurance that earn cash value.

Term life insurance does not earn cash value or have this feature available but is generally cheaper than permanent policies.

What Is Cash Value Life Insurance?

Cash value life insurance is a type of permanent life insurance that earns money and provides a death benefit to a beneficiary. The cash value investment feature of a permanent policy also earns interest.

Universal life and whole life insurance are types of life insurance that have cash value. A life insurance policy that provides a policy owner with cash value is generally more costly than term life insurance, which doesn’t earn cash value.

The policyholder can borrow against or withdraw the balance of the cash value account in an emergency. Other types of life insurance policies build cash value, and depending on the policy details, there are various ways to use it.

Types of Life Insurance Policies With a Cash Value
Policy Type

Whole Life Insurance

This is the simplest type of permanent life insurance. The cash value of a whole life insurance policy earns interest at a fixed rate determined by the insurance company and defined prior to purchasing the whole life policy.

Guaranteed Acceptance Life Insurance

This is a type of whole life insurance that also earns cash value interest at a fixed rate. Its premiums and cost are higher, which leaves a smaller portion of the premium to be set aside for the cash value account.

Simplified Issue Life Insurance

This form of whole life insurance features fixed-rate growth for the cash value account. This policy may grow cash value faster than a guaranteed issue but not as fast as a whole life insurance policy.

Universal Life Insurance

Universal life insurance cash value has a minimum guaranteed growth rate but also aligns with market rates and the insurance company’s financial performance. The interest rate floor allows the cash value to grow at a predictable rate, even if the carrier or investment growth is poor.

Variable Universal Life Insurance

Variable universal life insurance allows policyholders to accelerate their cash value growth potential by investing in subaccounts like bonds, mutual funds or stocks. Growth is based on investment performance, and the cash value can experience negative growth if market performance is down.

Indexed Universal Life Insurance

Similar to variable life insurance, indexed universal life insurance uses a stock market index to determine cash value growth. Performance is tied to the market index of the policyholder’s choosing, such as the S&P 500 or the Dow Jones Industrial Average.

Cost of Cash Value Life Insurance Policies

Cash value life insurance can be more expensive than term life insurance because it offers both a death benefit and a savings or investment component that can grow over time.

The costs associated with a life insurance policy with cash value can also vary significantly from person to person due to a variety of factors.

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    The older you are, the higher your premiums will be for life insurance with cash value. This is because the risk of death increases with age, and insurance companies charge higher premiums to compensate for this increased risk.

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    If you have health issues, you can expect to pay higher premiums for a cash value life insurance policy. Insurance companies assess your health to determine your life expectancy and the likelihood of paying out the death benefit.

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    Policy Type

    Different types of cash value life insurance policies have varying costs. Whole life insurance typically has higher premiums than universal life insurance but also offers a guaranteed cash value growth rate.

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    Coverage Amount

    The more coverage you want, the higher your premiums will be. The death benefit amount is a significant factor in determining the cost of your premiums.

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    Adding riders to your policy can increase the cost. Riders are additional benefits that you can add to your policy, such as a waiver of premium rider or an accelerated death benefit rider.

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    The cost of living and regulations in your area can affect the cost of your premiums. For example, if you live in an area with a high cost of living, you may pay higher premiums.

When you pay premiums for a cash value life insurance policy, the money is divided into three parts: insurance cost, overhead and fees and the cash value. The cost of insurance and overhead fees are deducted first, and the remaining amount is added to the cash value of a life insurance policy.

How Cash Value Life Insurance Works

Cash value life insurance works as a savings and investment vehicle inside the life insurance policy. Part of the premium goes into the cash value account, which can grow over time. The insured can access this benefit during their lifetime and use it in various ways. If any value remains when the insured dies, the rest goes back to the insurance company.

Buy a Cash Value Life Insurance Policy

The first step to getting cash value life insurance is buying a policy. You should determine your life insurance needs and your goals for the cash value to help you decide which cash value life insurance policy is right for you.

Pay Premiums to Build up Cash Value

Every premium payment is divided between the cost of insurance and the cash value account. In the early years of your policy, more of the premium is allocated toward the cash value. The older you are, the more expensive insurance becomes, reducing each premium payment's cash value accumulation.

Accumulate Cash Value

It can take several years of accumulation before the cash value account builds up enough for you to access it. During this time, the value of the account can grow, either at a fixed or variable rate, depending on the policy type and investment method. The cash value for whole life insurance and universal life insurance grows at a fixed rate, while indexed and variable universal life insurance grows at variable rates.

Use the Cash Value

Once the cash value of life insurance has grown to a point where you can access it, it’s available to use as a living benefit. There are several ways to use a life insurance policy's cash value, including:

  • Making partial withdrawals
  • Taking out a loan
  • Withdrawing the cash value and surrendering the policy
  • Using the cash value for paid-up additions or buying more life insurance
  • Using the cash value to pay policy premiums
Understand How Using the Cash Value Could Affect the Policy

Using the cash value of a life insurance policy may have the following effects:

  • If you make a partial withdrawal and don’t repay it, the unpaid amount will reduce the death benefit paid to your beneficiary.
  • If you borrow against the cash value, expect to pay it back with interest or lower the death benefit amount.
  • Withdrawing the entire cash value amount will cancel the policy and leave you without life insurance coverage.
  • Using the cash value to buy more life insurance or pay premiums can free up money elsewhere but will reduce or eliminate the cash value growth.

Tax Implications of Cash Value Life Insurance

The growth of the cash value in a life insurance policy is tax-deferred, which means taxes on this growth are not due until the funds are withdrawn. Other tax implications include:

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    Loans taken against the cash value are generally not taxable as long as the policy is not surrendered or lapses. This can be a significant advantage if you want to access funds without tax liability. If you don't repay the loan, the death benefit paid to your beneficiaries will be reduced.

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    Withdrawals are taxable if they exceed the amount you've paid in premiums. If you've paid $10,000 in premiums and then withdraw $15,000, you will owe taxes on the $5,000 difference.

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    If you surrender the policy, any gains are taxable as income. This means that if the cash value of your policy has grown beyond the amount you've paid in premiums, you will owe taxes on the difference.

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    Death Benefit

    The death benefit is generally not taxable to the beneficiary. This makes life insurance an attractive option for transferring wealth to the next generation without incurring estate taxes.

Consider consulting with a tax professional to understand the specific tax implications for your situation. They can help you navigate the complex tax rules and ensure you maximize the tax advantages offered by cash value life insurance.

Benefits of Building Cash Value on a Life Insurance Policy

Building cash value on your life insurance policy provides a living benefit you can use if needed. This nest egg can be a valuable asset down the road. There are several ways to utilize life insurance cash value.

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    Make a Withdrawal

    The amount you withdraw from the cash value is generally tax-free unless the amount is greater than the premiums paid into the policy. Making a withdrawal without paying it back will reduce the death benefit.

    You can use the cash value to fund large expenses, such as a child’s college expenses, supplemental retirement income, a down payment for a house or emergency funds.

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    Take Out a Loan

    Another option is to take out a loan from the cash value account. Interest accumulates when you take out a loan, but the interest rate can be more favorable than rates offered by a bank. If you don’t repay the loan and interest before you die, the outstanding balance will reduce the death benefit amount your beneficiary receives.

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    Buy More Life Insurance

    If you buy whole life insurance from a mutual insurance company, you might earn dividends at the end of the year. These dividends can buy more permanent life insurance, called paid-up additions (PUA). The policies are paid in full and eligible to earn dividends and cash value.

    The policy might also include a rider for paid-up additions. The PUA rider comes with an extra cost, which is allocated to buy more paid-in-full whole life insurance. In later years, the paid-up additions can pay premiums or surrender the policy.

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    Surrender the Policy

    If you decide down the road that you no longer need the life insurance policy, you can surrender it. The insurance company usually assesses surrender fees in the first decade or two of the policy. If you surrender the policy, you’ll receive the life insurance net cash value, which is the cash value amount minus any surrender fees and outstanding loan balances. The policy is then canceled, and you no longer have life insurance coverage.

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    Pay Premiums

    Once a sufficient amount of cash value has accumulated, you can use the cash value to pay your premium. This can free up cash in your budget without sacrificing the death benefit coverage. However, you’ll need to keep a close eye on the policy, as draining the cash value can cause it to lapse.

Pros and Cons of Cash Value Life Insurance

While there are some advantages to consider, cash value life insurance also has disadvantages. Weighing the pros and cons can help you decide which type of policy is best for you.

Pros of Cash Value Life Insurance

Cash value life insurance offers a blend of life insurance protection and investment opportunities. Here are some of the key advantages:

  • Lifetime Coverage: Unlike term life insurance, cash value life insurance provides coverage for the insured's entire life. This lifelong protection ensures that beneficiaries receive a death benefit regardless of when the insured passes away.
  • Cash Value Accumulation: The policy's cash value grows over time, often at a guaranteed minimum rate. You can use this accumulation for various financial needs, such as retirement planning or emergencies, providing additional financial flexibility.
  • Potential for Dividends: Some cash value life insurance policies, particularly whole life, may pay dividends. You can take the dividends as cash or use them to purchase additional coverage or reduce premiums.
  • Tax Advantages: The growth of the cash value is tax-deferred, and loans against the cash value are generally tax-free. These tax benefits can enhance the policy's overall financial value.

Cons of Cash Value Life Insurance

While cash value life insurance offers several benefits, it's also important to understand the potential drawbacks. Here are some of the key disadvantages:

  • Higher Premiums: Cash value life insurance premiums are typically higher than term life insurance premiums. The added cost reflects the investment component and lifelong coverage, which may not be necessary for all individuals.
  • Potential Tax Liabilities: If not managed properly, actions like withdrawing more than the premiums paid or surrendering the policy can lead to tax liabilities. Proper understanding and management are essential to avoid unexpected taxes.
  • Limited Investment Options: Depending on the policy type, investment options for the cash value may be limited. This restriction can hinder the potential for higher returns, particularly in favorable market conditions.
  • Risk of Policy Lapse: If the policyholder fails to pay premiums or mismanages loans against the cash value, the policy may lapse.

Consider how these drawbacks may impact your specific financial circumstances and the potential advantages of cash value life insurance policies.

Who Should Get a Cash Value Life Insurance Policy

A cash value life insurance policy is best for someone who has already maxed out other tax-advantaged savings vehicles, such as a 401(k) or IRA. It can also be a good fit for those with permanent life insurance needs, like paying for end-of-life expenses or someone with a dependent special needs child.

For most, term life insurance is sufficient if you’re solely looking for an affordable death benefit, with other options for investment savings.

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    You Want Lifetime Coverage

    One thing term life insurance can’t offer is lifetime coverage. Cash value life insurance can provide a guaranteed death benefit, no matter how long you live. If you buy term life, it only lasts for a certain number of years. Once it expires, you no longer have coverage. As long as you continue to pay your premiums, whether through cash or accessing the cash value, permanent life insurance will stay in force, providing a guaranteed death benefit to your beneficiary.

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    You Want to Supplement Retirement Income

    If you buy a permanent life policy when you’re young and continue to fund it, the cash value can grow exponentially. You can then withdraw some of the cash value to supplement retirement income or use it to pay the premiums so you still have “free” lifetime coverage.

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    You Want to Use It as Part of an Estate Planning Strategy

    High-income earners often use permanent life insurance as part of an effective estate planning strategy. The policy is federally tax-free and is not part of the estate when a person dies. Beneficiaries can also use death benefit proceeds to pay estate taxes, greatly reducing or eliminating out-of-pocket costs when a loved one passes away.

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    You're a Business Owner

    Business co-owners can fund a buy-sell agreement using life insurance, which covers each owner if the other dies. A business can also buy insurance on a key person, which could be a founder, owner or key employee. The business is listed as the beneficiary, so the death benefit proceeds of a keyman policy can be used to hire and train a replacement, pay off debts or continue operations.

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    You Can Sell the Policy

    If you no longer need the life insurance policy but don’t want to surrender it, you could sell it. Life insurance settlement companies or brokers can facilitate the sale, taking a fee to help you offload the policy. This is often a complex solution and could end up costing more than surrendering the policy and paying fees assessed by the insurance company.

Who Cash Value Life Insurance Policies Are Not Suited For

Cash value life insurance is a type of life insurance that combines the protection of a death benefit with the opportunity to build cash value over time, but it may not be the right fit for everyone. Here are some scenarios where cash value life insurance might not be the best choice:

  • Affordability: If you're seeking a more budget-friendly option, term life insurance is generally less expensive than cash value life insurance. Term life insurance provides coverage for a specified term, such as 10, 20 or 30 years, and does not include a cash value component. This makes it a cost-effective solution for individuals who need life insurance coverage for a specific period, such as while raising children or paying off a mortgage.
  • Investment Component: Cash value life insurance policies include an investment component that allows the policyholder to build cash value over time. A term life insurance policy might be a better fit if you're not interested in this feature. With term life insurance, you're not paying for the investment component, which can result in lower premiums.
  • Permanent Coverage: Cash value life insurance is a type of permanent life insurance that provides coverage for the policyholder's entire life as long as the premiums are paid. If you don't need life insurance coverage for your entire life, a term life insurance policy might be more appropriate. Term life insurance provides coverage for a specific term, and once that term expires, the coverage ends.

In addition to these considerations, think about your financial goals and needs when deciding whether cash value life insurance is right for you.

Alternatives to Cash Value Life Insurance Policies

If cash value life insurance is not the right fit for you, consider exploring alternatives. Each of the following options has its pros and cons, so carefully consider your needs before making a decision.

Term Life Insurance

Term life insurance provides coverage for a specific term, usually 10, 20 or 30 years. It is generally more affordable than cash value life insurance and is a good option if you only need coverage for a specific period. Term life insurance is straightforward and easy to understand, making it a popular choice for many individuals.

Investment Accounts

Consider investing in mutual funds, stocks or bonds as an alternative way to grow your savings. Investment accounts offer the potential for higher returns compared to traditional savings accounts, but they also come with higher risks. Carefully research and understand the different investment options available to determine the best strategy for your needs.

Savings Accounts or Certificates of Deposit (CDs)

These are low-risk options for growing your savings, although the returns may be lower compared to other investment vehicles. Savings accounts and CDs are insured by the Federal Deposit Insurance Corporation (FDIC), which means your money is protected up to $250,000 per account.

Real Estate

Investing in real estate can yield rental earnings and the possibility of an increase in property value. Note that this type of investment carries certain risks, including the responsibilities of property management and the potential for market volatility. Carefully research and understand the real estate market before making an investment.

Having a comprehensive and wide-ranging financial plan is often the best approach. A well-rounded financial plan takes into account your unique needs, goals and risk tolerance, including a mix of different financial products and strategies to help you achieve your objectives. This may include a combination of life insurance, investment accounts, savings options and other financial products. By diversifying your financial portfolio and taking a holistic approach to your finances, you can maximize your potential for growth while also managing risk.

FAQ About Cash Value Life Insurance

Life insurance with cash value is great for some, but not everyone. Here are the answers to some of the most common questions about cash value life insurance.

What is cash value life insurance?
How does cash value life insurance work?
Which types of life insurance have a cash value?
What are the benefits of a cash value in life insurance?
Can you lose money in the cash value of a life insurance policy?
What happens if you surrender a permanent life insurance policy?
Do you have to pay back cash value withdrawals?
What happens if the policyholder passes away without withdrawing their policy's cash value?
Is cash value life insurance a good investment?
Does whole life insurance have cash value?
How does whole life insurance build cash value?
How do you determine the cash value of life insurance?
How do you get cash value life insurance?
What could result from taking out a cash value loan under a life insurance policy?

About Mark Fitzpatrick

Mark Fitzpatrick headshot

Mark Fitzpatrick has analyzed the property and casualty insurance market for over five years, conducting original research and creating personalized content for every kind of buyer. Currently, he leads P&C insurance content production at MoneyGeek. Fitzpatrick has been quoted in several insurance-related publications, including CNBC, NBC News and Mashable.

Fitzpatrick earned a master’s degree in economics and international relations from Johns Hopkins University and a bachelor’s degree from Boston College. He is passionate about using his knowledge of economics and insurance to bring transparency around financial topics and help others feel confident in their money moves.