What is cash value life insurance?
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In addition to death benefits, life insurance can offer different benefits to policyholders and beneficiaries, depending on the type of policy you choose. For example, permanent life insurance policies offer a cash value component. Cash value life insurance essentially functions as an interest-bearing savings or investment account, and the account is funded in part by your policy premiums.
The unique benefit of a cash value life insurance policy is that it typically allows you to pull money in the form of a withdrawal or loan from the cash value account while you’re still living. But while the cash value account feature may be appealing, this type of policy won’t be the right fit for every person. If the idea of getting cash value life insurance intrigues you, here’s what exactly it is, how it works and the types of policies that exist.
How does cash value life insurance work?
Cash value life insurance has a death benefit portion that works the same as any other life insurance policy. This death benefit is paid out to your beneficiaries upon your death.
However, the cash value component operates differently. Each month you pay your premium, and a portion of your payment is diverted into a separate savings or investment account. You can spend this money through withdrawing funds, taking out a loan, surrendering the policy or even using the money to pay your premiums.
The money you pay into your policy funds the following categories:
- Cost of the insurance: Every month, part of your premium contributes to your death benefit coverage that will be paid out upon your death.
- Overhead and fees: You’ll also pay money towards the insurance company’s operating costs and you’ll pay fees associated with your cash-value account, just like with any other investment account.
- Cash value: Some of the money will be diverted into the savings or investment account associated with your cash value policy.
Types of cash value life insurance
If you’re looking for a cash value account to augment your life insurance policy, you may be wondering what policy types you can choose. Thankfully, you can get cash value life insurance with several policy types.
- Variable universal
- Indexed universal
Learn the differences so you can pick the best choice for you.
Whole life insurance
With a whole life insurance cash value policy, your premium stays the same for the rest of your life. A small percentage of your premium goes into a savings account that accumulates interest. The rate of return on this account will vary with each company. Typically, you can use funds from this account prior to death.
Variable life insurance
Unlike whole life insurance, variable life insurance allows you to choose how your accumulated cash is invested. Instead of having it sit in a savings account, you have a few more choices. For example, you can invest it in stocks or bonds.
There are two cons with this type, however. First, you have to know what you’re doing, and variable life insurance has higher fees than whole and universal cash value life insurance.
Universal life insurance
With universal life insurance, you have some control over what you pay for your premium. For instance, if you have a good month, you could overpay what you normally would and have the surplus go into your savings account. Likewise, if one month you’re a little short, you can use your savings account to pay your monthly premium.
To complicate matters even further, there are three types of universal life insurance. They are guaranteed universal life, indexed universal life and variable universal life. Which type you choose changes how your money builds up month to month.
Variable universal life insurance
With variable universal life insurance, part of your monthly premium will go into an investment account. The premium you pay is flexible meaning you can divert more money each month into this account if you choose. Keep in mind, however, that these policies usually have a cap and floor on the returns that you can receive.
Indexed universal life insurance
Along with a death benefit, indexed universal life insurance policies offer a fixed account or an equity-indexed investment that can earn interest.
How to use the cash value from your life insurance
If you’d like to use your cash value account prior to your death, you can do so in the following ways.
- Make a partial withdrawal: You can withdraw money straight out of your cash-value account, but there’s a catch: when you do, the amount of money your beneficiaries receive when you die decreases. Even though it’s money that you deposited, if you use it, your life insurance policy goes down.
- Take out a loan: You can take out a loan against the cash value you’ve built up. However, consider this: You’re going into debt over money that’s yours, and you’re paying interest on top of it. Should you be unable to pay it back before you die, your death benefit to your family will decrease.
- Pay your premium: Use any amount of money you’ve accumulated to pay for your monthly premium. Depending on which life insurance company you work with, there may be a withdrawal fee to do so.
- Sell your policy: Once all of your children have grown up or you don’t feel as if there is a need to have life insurance anymore, you can sell your policy for a cash settlement
- Surrender your policy: Instead of selling your policy, you can instead surrender it. Any cash value you’ve built up over the years will be given to you after numerous fees are taken out. If the cash value is more than you’ve paid in premiums over the years (which is unlikely), you’ll be taxed on any profits you’ve made.
Pros and cons of cash value life insurance
|You can spend from your cash value account while you’re alive.||You may have fees associated with your cash value account.|
|You can earn interest on a cash value savings account.||Cash value policies are more expensive than term policies.|
|You can earn returns on a cash value investment account.||If you remove money from your cash value account, your death benefit decreases.|
|You can overpay on your premium and divert more money into your cash value account|
Frequently asked questions
The death benefit and cash value of a life insurance policy are handled differently after you die. Unlike the death benefit, which is paid to your beneficiaries after you pass away, the cash value of your life insurance policy does not get paid out to the people you name as beneficiaries. The money that has accumulated in your cash value account over the years is kept by the insurance company instead.
Yes, if you have cash value as part of your life insurance policy, you can withdraw a portion of the money from your cash value savings account. If you withdraw more money than you’ve put in — meaning you take out an amount that includes any gains you’ve made — the money you withdraw will be taxed at the income rate you’re typically taxed at. Plus, your death benefit will then be reduced by whatever amount you withdraw (whether you dip into gains or not).
If you’re fine with your death benefits decreasing, you can withdraw any amount you’ve put into your cash value savings account.
Yes, guaranteed issue life insurance policies have tax-deferred savings accounts that accumulate interest.
Correction, Feb. 10, 2023 5:32 pm ET: The previous version of this article implied that cash value life insurance was separate coverage within a permanent life insurance policy. This has been corrected to clarify that cash value is part of a permanent life insurance policy. Other corrections were made to clarify limitations or features available with cash value coverage, such as how a withdrawal works and fees associated with cash value accounts.