Shopping for life insurance can be a daunting task. It can be hard to figure out what makes the most sense for your financial situation with different policy types, riders, and head-scratching terminology (accelerated death, anyone?).
Cash value is a component of some types of life insurance. this is a feature typically offered within permanent life insurance policies, such as whole life insurance and universal life insurance.
Reading: How to cash in life insurance value
Policyholders can use the cash value as an investment-like savings account and draw money from it.
While purchasing cash value life insurance may seem like a smart choice, it’s not always the right one. Here’s what you need to know about cash value life insurance.
what is cash value life insurance?
Cash value life insurance is a policy that contains a cash value account. this cash value component typically earns interest or other investment earnings and grows tax-deferred.
You have several options if you want a cash value life insurance policy. Each type of policy builds cash value differently, but in all cases, you can get your cash value through a loan, withdrawal, or surrender. Here are five types of cash value life insurance.
types of cash value life insurance
whole life insurance
Whole life insurance is a type of permanent life insurance that is possibly the simplest cash value policy. Whole life policyholders don’t have to decide how the cash value should be invested. the insurance company provides a fixed rate of return to increase the cash value.
here is a summary of whole life insurance:
- offers a fixed monthly premium and a guaranteed death benefit.
- Your premium payments do not change over time.
- cash value accumulates at a guaranteed minimum rate.
- You can build cash value faster if you receive dividends from the business and deposit them into your cash value account each year.
- whole life insurance guarantees make it a more expensive life insurance option than others.
- Often available only in small coverage amounts, such as $20,000.
- may include cash value, but since coverage amounts are small, potential cash value is small.
- Guaranteed issue life insurance has a tiered death benefit: your beneficiaries won’t get full payout if you die within two or three years of purchasing the policy, unless the death is due to a accident. The exact rules about graduated death benefits may vary, so make sure you understand them before you buy guaranteed issue life insurance.
- Some types of universal life insurance offer the ability to accumulate higher cash value, but also with some risk of loss.
- Some types of universal life insurance give policyholders the option to adjust premiums and death benefits, within certain limits.
- Similar to whole life insurance because the premiums are constant.
- cash value accumulation may be minimal.
- Typically the least expensive universal life insurance option.
- Your cash value growth is related to gains and losses in an index, such as the s&p 500.
- You can usually adjust premiums and death benefits within certain parameters.
- Cash value growth is tied to subaccounts, including stocks and bonds, that contain the investments you choose.
- Usually you can change your premium and death benefits within set limits.
- Your investment decisions could result in the loss of money in your cash value.
- on the cash value of the policy
- up to the cost of insuring it
- to policy charges and changes
- California allows insurance companies to charge a maximum flat rate of up to 8% per year.
- florida allows up to 8% for a maximum fixed rate.
- new york allows insurers to charge up to 7.4% interest on a fixed loan and up to 8% on adjustable rate policies.
- texas law says the maximum fixed rate cannot exceed 10% per year. texas allows up to 15% for policies with a maximum adjustable interest rate.
- taken as cash
- added to your cash value
- used to pay premiums
guaranteed issue life insurance
Guaranteed issue life insurance is a type of whole life insurance. you cannot be turned down, and the application process has no medical exam or health questions. These whole life policies are sometimes called burial insurance, funeral insurance, or final expense insurance.
universal life insurance
Universal life insurance policies are the most common cash value life insurance policies. Not all types of universal life insurance build cash value well, so make sure you understand what you’re buying if you’re looking for cash value growth.
Let’s dig deeper to show the difference between the types of universal life insurance.
guaranteed universal life insurance
indexed universal life insurance
variable universal life insurance
How does cash value life insurance work?
Premium payments for cash value life insurance go in three places:
so only a portion of what you pay ends up in cash value.
You can withdraw money from the cash value or take a loan against it and use the money for whatever you want. that could be for an emergency, supplementing retirement income, and paying premiums. there is no limit to how you can use the cash value.
You can also take your cash value if you decide to cancel the policy. If you cancel the policy with the insurer, you receive the amount of the cash value less any surrender charges. this action ends life insurance coverage.
There is usually a surrender charge if you terminate the policy within the first few years of purchasing it. The surrender charge is a way for the insurer to cover the cost of issuing you the policy.
how to use cash value to pay premiums
If you accumulate enough money in your cash value account, you may be able to use your cash value to cover your premium payments. If you’re having trouble making payments, this option may provide some relief so you can keep your life insurance in force.
If you use up all the cash value in the account, the policy could lapse, so be aware of your cash value level.
Talk to your insurance company to find out their rules for using cash value for your premiums.
You can tap into the cash value of a policy while you’re alive with the methods below.
take a loan against the cash value
You can borrow against the cash value of a permanent life insurance policy. your loan amount accrues interest until it is paid in full.
The interest on a policy loan can be a fixed or variable rate calculated by the insurer based on current market rates.
State law often dictates the maximum policy loan interest rate. for example:
If you default on the loan amount and die, the insurance company subtracts the outstanding loan balance (including interest) from the life insurance payment to your beneficiaries. Some policyholders choose to use their cash value in this way and intend for their beneficiaries to get a reduced payment.
Another advantage of a policy loan is that it does not appear on your credit report.
withdraw funds from cash value
It is also possible to make withdrawals from your policy. If the amount you withdraw includes investment earnings, often called the “on basis” portion, that portion is taxable. As with a policy loan, making a withdrawal reduces the life insurance payout to your beneficiaries later.
deliver the policy for cash
giving up an insurance policy means you’re dropping coverage. When you surrender a policy, you can get back the cash value less any surrender charges.
The insurance company also subtracts any unpaid premiums or outstanding loan balance. Still, getting some money back is better than just walking away from the policy empty-handed if you don’t want it anymore.
cash value life insurance benefits
Whether cash value life insurance is right for you depends on why you want a policy. These are the benefits of a cash value life insurance policy.
your beneficiaries receive a death benefit
Cash value life insurance is a permanent life insurance policy, which means it can stay in force until you die, as long as you pay your premiums. if you take loans or policy withdrawals, you also need to make sure you maintain a minimum level of cash value or your policy could lapse.
If you want to make sure your loved ones get something, a cash value policy is probably a better option than term life insurance.
participating life insurance policies may have dividends
Many whole life insurance policies are “participating,” meaning the policy owner can get dividends if the policy is from a mutual insurance company.
dividends can be:
Dividends can also be used to purchase “paid-in additions” to your life insurance policy, increasing the amount of the death benefit for beneficiaries.
Having a participating policy is one way to lower the overall cost of your life insurance.
additional clauses for additional coverage
Most types of life insurance have options to add riders that add additional coverage or features. One of the most common life insurance riders is an accelerated death benefit, which is often included automatically. this gives you access to your own death benefit while you are still alive if you are diagnosed with a terminal illness. It can be helpful in paying medical bills and other unexpected costs.
Similar chronic illness and long-term care riders also allow you to access your death benefit if you have certain medical conditions. Your life insurance agent can tell you the rider options available with your policy before you buy it.
tax advantages of cash value life insurance
There can be several tax advantages to purchasing life insurance, and specifically a cash value life insurance policy. A primary tax benefit is that your beneficiaries receive the death benefit tax-free, as with any type of life insurance. Since life insurance payout amounts can be quite large, this is a major advantage.
another tax advantage is that the total cash value accumulates tax deferred. so as your cash value grows, the irs doesn’t take a cut of it.
Also, if you borrow money against the policy, you won’t have to pay taxes on the loan, just like you wouldn’t have to pay taxes on a personal loan. the loan is not subject to taxes as long as the policy is in force.
If you withdraw the cash value or take the surrender value and rescind the policy, you may pay taxes on the portion of the money that comes from interest or investment earnings.
Therefore, it’s important to understand the tax rules before you take money out so you don’t get hit with a surprise tax bill.
Disadvantages of Cash Value Life Insurance
Cash value life insurance isn’t for everyone. Here are some potential negatives of cash value life insurance.
cash value life insurance is more expensive than term life insurance
Cash value insurance costs more than term life insurance.
If you need life insurance because you want to cover a specific debt or a certain amount of time, look into term life insurance. does not offer a cash value component, but will pay a death benefit amount of your choice if you die while the policy is in force.
Term life insurance is ideal for covering the years you’re paying off a mortgage or the years until your children are expected to be financially independent. And it won’t cost you an arm and a leg like some forms of cash value life insurance, like whole life insurance. If you don’t need insurance for your entire life, term life insurance will give you the most coverage for your money.
many term policies also allow you to convert term life insurance to permanent life insurance later.
Life insurance is designed as a financial safety net for your loved ones if something happens to you. While cash value life insurance may seem tempting, there’s no point in paying the higher price if you don’t need insurance indefinitely.
Related: Comparing Term Life Insurance vs. Whole Life Insurance
cash value can take time to build
Some policies take a long time to accumulate significant cash value. you could wait decades before having a substantial amount to access. There are some life insurance policies designed for faster cash accumulation in the early years of the policy. work with an experienced life insurance agent who can guide you to the right products.
no cash value is paid to beneficiaries
When you die, the cash value usually reverts to the life insurance company. Your beneficiaries receive the amount of the policy’s death benefit, less any cash value loans and withdrawals you’ve made. That said, there are some policies that will pay the death benefit plus cash value to beneficiaries, but be prepared to pay a lot more for this feature.