Updated: August 2016
There's more to life insurance than meets the eye. Most people understand that life insurance provides a face value, the amount that's paid out to beneficiaries when the insured dies. But not everyone knows that some life insurance policies offer an important, additional feature — one that might make your policy more valuable while you're still alive.
You're probably familiar with how life insurance works. You can typically choose the amount your beneficiaries would receive if you pass away. But that's not the only benefit some plans offer.
Cash value is a feature specific to permanent life insurance, one of the two major types of life insurance policies.
A portion of each payment you make to a permanent life policy goes toward insuring your life, and the other portion goes toward building up cash value.
As you pay your premiums, the cash value portion earns interest. Then, you may be able to withdraw or borrow against it in case of an emergency.
So, how can you access your policy's cash value? One way is to make a withdrawal.
Another way is with a loan. You may be able to borrow up to the cash value amount on your policy.
Finally, you may be able to use your policy's cash value to help pay premiums.
Be sure you understand the consequences of each of these choices. Loans or partial withdrawals may reduce your policy's death benefit, increase the possibility of policy lapse and result in a tax liability.
It's called cash value, and it's a feature that's specific to permanent life insurance, one of the two major categories of life insurance policies.
A portion of each payment you make to a permanent life policy goes toward insuring your life (the face value), while the other portion goes to building up a cash value.
Over time, as you pay your premiums and the policy earns interest, the cash value accumulates and becomes available for you to withdraw or borrow against in case of an emergency. It's a feature of permanent life insurance that the Insurance Information Institute (III) describes as "a kind of 'forced' savings plan" for a policyholder.
Cash value can be a quick source of money in an emergency to make a down payment on a home or to help pay for college tuition.
However, you should also keep in mind that loans or partial withdrawals can reduce the policy's death benefit, increase the possibility of policy lapse and may result in a tax liability.
Here are some of the ways you can access your policy's cash value:
Make a withdrawal¹. You can usually make a tax-free withdrawal up to the amount you've already paid into the cash-value portion of your policy, according to personal finance publisher Kiplinger. If your withdrawal exceeds that amount, it'll be taxed as income. In either case, the death benefit is reduced by the amount that you withdraw, Kiplinger says.
Take out a loan¹. You can typically borrow up to the cash value on your policy (that would include the portion of your paid premiums that have been designated for the cash value account, along with any accrued interest on those funds). According to the III, the loan isn't considered taxable income, and, since you're borrowing against your own money, it doesn't affect your credit report. If you die before you repay the loan, however, the outstanding amount is subtracted from your death benefit. Regardless, until you pay the loan back, you're continually accumulating interest on it, which can eat away at your potential death benefit.
Surrender the policy. A surrender is essentially a cancellation of your policy (you'll no longer be covered by life insurance). According to Kiplinger, you'll receive the amount in the cash-value account, minus any loans or unpaid premiums.
Use cash value for premiums. If you come up short of cash, you may be able to stop paying the premiums and, instead, allocate the cash value of your policy to cover them, the III says. But if you end up depleting the funds in the cash value account entirely, it can cause your policy to lapse, which would end your life insurance coverage altogether, the association warns.
Having investment options 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 probably best to talk with an insurance agent to help you decide what option might be best for you.