What is cash value life insurance?
Last updated: September 2023
Cash value life insurance is a type of permanent life insurance that includes an investment feature. Cash value is the portion of your policy that earns interest and may be available for you to withdraw or borrow against in case of an emergency.¹
What types of life insurance offer cash value?
How does cash value life insurance work?
Some permanent life insurance policies offer two features:
- Death benefit, the amount that's paid out to beneficiaries when the insured person passes away. This is often referred to as the "face value" of your policy, or the amount of life insurance coverage you purchased (for example, a $500,000 whole life insurance policy). Face amount is the initial benefit amount purchased. Death benefit is what is actually paid out. This amount is less loans and interest and if whole life, premiums due.
- Cash value, an additional feature that might make your policy more valuable, because you may be able to access the money while you're still alive.¹
With a cash value life insurance policy, a portion of each premium you pay goes toward insuring your life, while the other portion goes toward building up a cash value. The cash value portion of your policy accrues tax-deferred interest. How the money earns interest depends on the type of permanent life insurance policy you purchase.
How can I withdraw cash value from life insurance?
Depending on the type of life insurance policy you have, here are four ways you may be able to access its cash value:
- Make a withdrawal
- Take out a loan
- Surrender the policy
- Use cash value to help pay premiums
Withdrawing money from your cash value policy¹
You may be able to make a tax-free withdrawal from your permanent life insurance policy. But, if your withdrawal exceeds the amount you've paid so far into the cash-value portion of your policy, it'll be taxed as income. Also, keep in mind that withdrawing your cash value funds reduces the death benefit that's paid out to your beneficiaries when you pass away.
Taking out a life insurance loan¹
You can typically borrow up to the cash value on your life insurance policy. This life insurance loan may include the portion of your paid premiums that have been designated for the cash value account, along with any accrued interest those funds have earned. According to the American Institute of CPAs, the life insurance loan isn't considered taxable income. If you die before you repay the loan the outstanding amount is subtracted from your death benefit. Regardless, until you pay the loan back, your debt is accruing interest, which can decrease your policy's potential death benefit.
Surrendering your life insurance policy for its cash value
A surrender is essentially a cancellation of your policy (you'll no longer be covered by life insurance). When you surrender your life insurance policy, your equity is the amount you've paid into the cash value portion of your account plus accrued interest. However, your insurer may subtract funds for any loans or unpaid premiums on the policy. And, you may be charged additional "surrender fees," which could further reduce your policy's surrender value, according to Investopedia. Finally, you could also be charged income tax on the money you receive from surrendering the policy.
Using cash value to pay premiums
If you're short on cash, you may be able to use the cash value in your policy to help pay your life insurance policy's premium. Check with your agent to see how this feature would work for your specific policy. Remember, though, if you deplete the funds in the cash value account entirely, it can cause your policy to lapse, which would end your life insurance coverage altogether.
Having emergency savings on a life insurance policy can be a source of comfort. But, since personal situations are unique, and the details of accessing cash value funds are complex, it's a good idea to talk with your insurer or an insurance agent to help you decide what option might be best for you.
Cash Value Life Insurance FAQs
The premium is what you pay toward your life insurance policy to keep it active. A portion of your premium goes toward the cash value of your policy. Consistently paying your premium contributes to the cash value’s growth over time.
Many life insurance policies also allow you to invest a portion of the funds in investment options like stocks. The performance of those stocks can directly impact cash value – for better or for worse. It’s important to gauge your risk tolerance and consult a qualified financial advisor.
If you cancel your life policy, the cash value you’ve built may be available to you. But the amount you receive will be less outstanding loans, interest and any unpaid charges. There also may be tax implications. If you’ve taken any loans out, you may be required to repay them in full.
Remember, surrendering or canceling a life insurance policy is a significant financial choice that can have long-term implications. Understanding the impact on the cash value and weighing it against your financial needs is crucial for making an informed decision.
Some policies may have requirements when it comes to withdrawing funds from the cash value of a life insurance policy. These include a minimum amount of cash value or a waiting period before you can make withdrawals.
Penalties can also come into play when withdrawing funds from the cash value. Depending on your policy, early or too many withdrawals can lead to consequences, including a reduction in the death benefit or even the complete termination of the policy. It's important to carefully consider the impact of these penalties before making any withdrawals.
Tax implications should also be considered. While some withdrawals may be tax-free up to the amount of premiums paid, any interest on the cash value may be taxed. Consult a tax advisor or financial professional who can provide clarity on the potential tax consequences based on your specific situation.
Yes, the cash value of a life insurance policy could be used as collateral for a loan. This can be a valuable option for policyholders who need access to funds while still maintaining their life insurance coverage.
It's important to note that the loan amount, along with any accrued interest, may need to be repaid to avoid potentially reducing the death benefit or canceling the policy. If the loan is not repaid, it may impact the long-term financial protection provided by the life insurance policy.
The cash value of a life insurance policy can play a significant role in estate planning and wealth transfer strategies. Estate planning involves organizing your assets and making decisions about how they’re distributed after you pass away. The cash value of a life insurance policy could contribute to your overall estate and potentially increase the total value of assets available for transfer. Including the cash value in your estate planning may help provide an additional financial resource for your beneficiaries.
There may be limitations on how the cash value can be invested within a life insurance policy and the specific investment choices available may depend on the insurance company and the type of policy you have. These restrictions are designed to manage risk and help maintain the stability of the policy's cash value. For example, there may be limits on the percentage of the cash value that can be used for certain types of investments or restrictions on investing in high-risk assets.
Additionally, insurance companies may have their own selection of pre-approved investment options. These pre-approved options may be subject to periodic review and change by the insurance company.
When a policyholder passes away, the fate of the cash value within a life insurance policy depends on the type of policy and its terms and conditions.
In many cases, the cash value is a part of permanent life insurance policies, such as whole life or universal life insurance. If the policyholder passes away, the death benefit is typically paid out to the named beneficiaries. But the cash value itself doesn’t typically transfer to the beneficiaries and is instead typically retained by the insurance company.
The cash value component of a life insurance policy may have an impact on the death benefit paid to beneficiaries.
In permanent life insurance policies, a portion of the premiums paid goes towards building cash value over time. As the cash value grows, it may increase the overall death benefit of the policy. This means that when the policyholder passes away, the beneficiaries may receive a higher payout, combining both the original death benefit and the cash value, as long as the policyowner had selected that option while the policy was still inforce. But note that the cash value itself is typically not paid out to the beneficiaries and is retained by the insurance company. Understanding the relationship between the cash value and the death benefit is crucial for policyholders and their beneficiaries to make informed decisions about their life insurance coverage.
Cash value life insurance policies may have potential tax advantages for policyholders. First, the growth of cash value within the policy is generally tax-deferred, meaning it grows without being subject to annual income taxes.
This allows the cash value to grow at a faster rate over time. Plus, policyholders may make tax-free withdrawals from the cash value up to the amount of premiums paid. These withdrawals are considered a return of basis and are not subject to income tax.
Secondly, the death benefit paid out to beneficiaries is typically income tax-free. It's important, however, to consult with a tax advisor to fully understand the specific tax implications and benefits of cash value life insurance policies based on individual circumstances.