Cash Value Life Insurance: Everything You Need To Know

Thang Truong
Thang Truong
Updated on:

Cash value is an important part of a permanent life insurance policy to consider. It’s the value you build on a life insurance policy above and beyond the death benefit. It is only available in permanent life insurance, so it is considered another name of permanent life insurance. If you’re interested in your life insurance policy working to help you grow your retirement income, you’ll want to look into this feature. Below we’ll look more in-depth at how cash value life insurance works, which types are available, and where you can find one.

What is Cash Value Life Insurance and How does It Work?

Cash value life insurance is simply a type of permanent life insurance that has a feature where you can grow money based on investments. Cash value life insurance policies have a certain amount of money that earns interest. This means that when you pay premiums for your life insurance policy, a portion of the premium is distributed to the cash value account earning interests, another portion of the premium is spent to insure you at the coverage amount you request.

In the initial years of the policy, a bigger share of premiums often go to the cash value account. However, as the insured gets older, the cost to insure will increase and more money from premiums will go to the insurance cost.

When you pass away, your beneficiaries will receive the death benefit. If any money still left in the cash value account, it will go to insurance companies.

What is Cash Value Account For?

Cash value is an account within your policy. As it builds up, you can have access to it. However, it usually takes a few years to build up, at least 3-5 years.

  • You can use cash value account to pay for premiums if your money is tight for a few months or even years.
  • You can withdraw from or borrow from the cash value account for any purpose from an emergency to supplemental retirement income.
  • And finally, you can surrender the policy if you have a surrender value available, providing that you pay surrender charges.
  • You can also use the cash value account as collateral for a loan. This is usually called collateral assignment of life insurance.

Types of Cash Value Life Insurance

Below are the types of life insurance that have a cash value component and a little about how they work:

Whole LifeIndexed Universal Life InsuranceVariable Universal Life Insurance
Interest/investmentIncreases at a set scheduleTied to market indexes such as S&P500Direct investment cover a wide range of investment products and assets

With whole life insurance, your cash value increases at a predetermined schedule. Meanwhile, indexed universal life insurance policies are tied to the performance of a certain market index, like the S&P 500. With variable universal life insurance, you invest your cash value into direct investments like stocks and bonds; your cash value performs based on what those investments do. Many cash value life insurance plans have interest floors so you cannot lose money beyond a certain amount.

Universal life insurance is another life insurance policy that provides cash value. However, with the increasing popularity of indexed universal life and variable universal life, universal life insurance has become less and less popular. Many insurance companies have discontinued universal life insurance in favor for indexed and variable policies.

>>MORE: Whole Life Insurance Cash Value: Everything You Need To Know

How to Get Money Out of Cash Value Account and Do You Have to Pay Tax?

There are many ways of getting money out of cash value account:

  • Withdraw from cash value account of universal life insurance policies, including universal, indexed universal, and variable universal policies. This option is not available in whole life policies. As long as your withdrawal mount is smaller than your total paid-in premiums, you don’t have to pay any tax nor interests.
  • Borrow from the cash value account. After withdrawing all of your paid-in premiums, you will start borrowing from the cash value account. As long as the policy is still in force, you don’t have to pay income tax on your loans. However, you have to pay interest rates on the loans to the policy. Insurance companies will get interest payment from the cash value account as well, which will decrease the cash value account faster. They usually charge 4-5% on loans against cash value account.
    • For whole life policies, with withdrawal is not an option, borrowing from cash value account is the only way to get access to cash value account. And whole life insurance companies charge higher interest rates, 8-10%, on loans.
    • If you don’t pay back the loans to the policy, death benefits will decrease by the withdrawal and loan amounts.
  • Mutual whole life insurance companies pay dividend to their policy holders. Dividends are usually used for paid-up additions, which is to add more insurance to the policy. However, you can decide to receive dividends in cash, entirely tax free.
  • Surrender permanent life insurance policies is another way to get cash out. When you surrender or cancel your policy, you will receive cash surrender value after paying surrender charge to insurance companies.
    • However, you have to pay income tax on the cash surrender value that you receive from cancelling your life insurance policy.
  • Selling your permanent life insurance policies is another option. Individuals or investment companies will buy your permanent life insurance policies for cash, which is usually more than the surrender value and less than the death benefit of the policy. The buyer will take over ownership of the policy and be responsible for paying premiums going forward and will receive death benefit from insurance companies when you pass away. Learn more about how to sell your life insurance policy.

Comparison of Cash Value Account of Whole Life, Indexed Universal, and Variable Universal Policies

Below we’ve included a chart comparing the cash value of whole life, indexed, and variable life insurance plans. We compared hypothetical policies for a man who started those permanent life policies when he was 45 years old with a death benefit of $150,000. Below are cash value of the policies at different years from the illustrations of the policies.

Year of PolicyPolicyholder’s ageWhole LifeIndexed Universal Life InsuranceVariable Universal Life Insurance

As you can see, the whole life plan goes up fairly steadily and predictably. The other two go up more drastically, especially the variable plan, since it’s tied into direct investments. This is, of course, for two hypothetical plans that performed fairly well based on rising markets. With the indexed and variable products, you’re increasing your risk by tying your cash value into the performance of markets and more direct investments, just like a mutual fund investment account.

Combining the function of a mutual fund investment account and free income tax when withdrawal and borrowing, an universal life insurance policy, either indexed or variable life insurance, has become a much more effective tool in retirement planning, especially if you want to combine the benefit of life insurance and supplement retirement income. Learn more how to use life insurance policy in retirement planning through a case study.

Final Thoughts

Cash value life insurance can help you grow your wealth based on investment return. It’s a part of a life insurance policy that grows apart from the base death benefit. These are solid products to look into if you want to use a life insurance policy to supplement savings or retirement income or have cash available in case of an emergency.

Thang Truong

Thang Truong covers small business insurance and small business success at BravoPolicy. He is a licensed P&C insurance agent. Previously, he held product leadership positions at, Capital One, NerdWallet, and Mulberry Technology. He holds a MBA degree from UC Berkeley - Haas School of Business.

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