Cash Value Life Insurance: What Is It & How Does It Work?
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Last updated 03/18/2024 by
Emma DillonFact checked by
Summary:
Cash value life insurance is a type of permanent life insurance with the added benefit of a cash savings account. A portion of your regular premium payments goes into your cash value account, creating a built-in savings fund that you can access while you’re alive. You can withdraw cash from this account or borrow from it. Just keep in mind that withdrawals may reduce the death benefit.
Life insurance plans generally come in handyafter death, but cash value life insurance plans can be helpful during your life as well. Cash value plans are a type of permanent life insurance with an attached investment account that grows over time. They can be a huge asset, allowing you to essentially borrow money from yourself, but there are pros and cons to consider. This guide is designed to help you decide if this type of policy is right for you.
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What is cash value life insurance?
Cash value life insurance is a type of permanent life insurance that includes a built-in savings fund available to the policyholder during their lifetime. With the addition of a cash value savings account, a permanent life insurance policy essentially sets up a savings fund that you contribute to each month with a portion of your regular premium payments.
Whole life vs. term policies
Permanent life insurance, also called whole life insurance, is a type of life insurance that does not expire (the policy lasts until you die). Permanent life insurance is more expensive than term life insurance, which has a fixed duration (usually 10-30 years).
Term life insurance does not typically include a cash value savings account. Premium payments you make for term life insurance policies only go toward your death benefit.
How it works
The goal of a cash value life insurance policy is to give the policyholder a kind of financial cushion to use while they’re still alive in case some unforeseen expense arises. The money saved in your cash value account is separate from the money in your death benefit, so your beneficiaries do not receive any of your cash savings. Remember, the money in this account is only to be used while the policyholder is alive. Any money in your cash value account that you don’t use while you’re still alive goes back to your insurance company when you die.
Your cash value account works much like an investment account: it grows tax-deferred, with interest, and can be used as collateral if you take out a loan from your insurer. Keep in mind, however, that it takes time to build a healthy cash value savings account. Plus, interest accrues slowly, so patience is key.
Pro Tip
Since whole life insurance policies have set rates, ask your insurance company about a life insurance rider to customize your policy. Common riders include accidental death and dismemberment and family policy add-ons.
Where do my premium payments go?
Your regular payments are split into two main categories: your cash value account and your death benefit amount. As mentioned above, your account is available to you during your lifetime. You can withdraw money from this fund (that you don’t have to pay back), or you can use it as collateral to secure loans from your insurer. A big plus is that if you use the funds as collateral on a loan, you aren’t subject to any credit checks because it’s your money.
How do withdrawals work?
Withdrawn funds are taken from the amount of money you’ve contributed to your account with premium payments (called your “basis”). You won’t owe taxes on the money you put in, but you will owe taxes on any earnings.
Some policies may limit how many times a year you can withdraw money or how much you can withdraw at one time. Additionally, the life insurance company may charge surrender fees, meaning that if you decide to cancel your policy within a certain time period, your cash value will be reduced. The surrender period can last several years, and in some cases, you will lose the entire cash value if you cancel your policy within the first couple of years.
How does your loan balance affect your policy?
While there may be limits to how much you can borrow from your policy, the loan amount you take out does not impact any part of your policy, credit report, or premium payments. If you take out a loan from your policy’s cash value account, you can pay it back to yourself tax-free or not at all, since you’re borrowing money from yourself. You may need to pay interest, and if you don’t pay back the loan, the loan amount will be deducted from your death benefit.
How does the death benefit work?
The death benefit in a cash value life insurance policy works the same as it would in any life insurance policy. Once you die, your beneficiaries receive whatever death benefit amount is stipulated in your policy. The premiums you pay during your lifetime go toward paying the insurance company back for the death benefit it awards to your family. Just remember: the money in your cash value account does NOT go to your beneficiaries when you die. That money goes back to the insurance company.
Example: If your death benefit is $50,000 and you have $5,000 in your cash account when you die, your beneficiary will receive $50,000.
Do my beneficiaries owe taxes on the death payout?
No, your death benefit is not taxable income for your beneficiaries. The IRS does not consider death benefit payouts taxable, but any interest earned on the death benefit after the policyholder’s death can be taxed. For that reason, it’s best for your beneficiaries to take the lump sum death benefit as soon as possible so it doesn’t start to accumulate taxable interest after your death.
Who should get a cash value life insurance policy?
Since cash value life insurance policies can take time to grow from interest, older individuals won’t benefit as much as a young person who takes out this type of policy. The goal is to give your cash value account as much time as possible to mature, so getting one while you’re young is your best bet.
How much does cash value life insurance cost?
According to Hugo Moreira, who breaks down complex financial topics at the blog Finance Stu, “Cash value life insurance can be more expensive than other types of life insurance, which can be difficult to afford. If you can’t keep up with the payments, you might lose the coverage altogether.”
Just like any insurance plan, it depends on the details of your policy. For example, a $250,000 policy could cost anywhere between $250 and $2,500 per month. Your premium payment can change depending on your age, health, coverage amount, and gender. Be sure to work with an insurance professional to choose the best policy for you.
Pro Tip
Once you have accumulated some money in your cash account, you may be able to use that money to pay your monthly premiums. Ask your insurance agent if this is an option with your policy.
Pros and cons for cash value life insurance
Find the right life insurance plan
Learn more about life insurance policies and read reviews of various providers to help you choose a plan.
Other types of life insurance
If a whole life cash value policy doesn’t sound like the best option for you, have no fear. Below are some alternative plans that may better suit your needs.
Universal life insurance
Universal life insurance is similar to permanent life insurance, with one key difference. Permanent life insurance policies have fixed premium rates, not subject to change while the policyholder is alive. Universal life insurance policies, on the other hand, have flexible rates.
Just like any cash value life insurance plan, universal life insurance has a cash value component that you can withdraw from and/or borrow against while you’re alive. (One type, indexed universal life, ties returns to the performance of an index like the S&P 500). However, with a universal life insurance policy, you can adjust your life insurance premiums as needed. You can also adjust the death benefit amount that your beneficiaries receive. That way, if your financial situation changes during your lifetime, you can raise or lower your premium as desired.
Term life insurance
Term life insurance is a type of life insurance that only lasts for a fixed period, unlike whole life insurance, which you have until you die. Term life insurance policies can last anywhere from 10 to 30 years. But your death benefit payout won’t go to your beneficiaries until after you die. In the event that you outlive your policy term, you’ll need to get a replacement policy to continue your coverage.
Check out our helpful term life insurance comparison tool to choose the best plan for you.
FAQ
Where can you get cash value life insurance?
Cash value life insurance policies are available anywhere permanent life insurance coverage is sold. If you already have an insurance agent, you can ask them about the life insurance policies they offer. Permanent life insurance and universal life insurance are the two types of insurance policy that allow a cash value account. If you opt for term life insurance, you won’t have the option of starting a cash value account.
Why is cash value life insurance not a good investment?
Some might argue that cash value life insurance is not a wise investment because the money in your cash value fund is not part of your beneficiaries’ death benefit payout. Instead, that money goes back to your life insurance company when you die. You may also owe fees on withdrawals that cut into the cash value.
Do you have to pay back cash value life insurance?
You do not have to pay back a loan from your cash value life insurance policy. But if you don’t, the amount you borrowed may be subtracted from your death benefit.
How soon can I borrow from my life insurance policy?
You can borrow as much as you’ve contributed to your cash account. So unless your policy restricts it, you can start borrowing as soon as you’ve built up some money in the cash value portion of your account.
Key takeaways
- Only permanent life insurance policies, such as whole life or universal life, have cash value components.
- Cash value accounts are similar to investment accounts and grow with time.
- Policyholders can access their cash value accounts during their lifetimes via withdrawals or loans. There may be restrictions on these withdrawals and surrender fees if the insured decides to cancel the policy.
- The funds in a cash value account are separate from the policy’s death benefit. The insurer keeps the cash value and distributes the death benefit after the policyholder dies.
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