Cash Value Life Insurance: Everything You Need to Know

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
• Supplementing retirement income
• A down payment for a house
• Emergency funds

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.

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.

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 balance. The policy is then canceled and you no longer have life insurance coverage.

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.

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.

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.

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.

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 in their business, 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.

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.