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Cash Value Life Insurance

What is Cash Value Life Insurance?

Cash value life insurance is permanent life insurance with a cash value component within the policy. That cash value grows at a rate dictated by the type of policy the individual purchased. Similarly, how the cash value can be used depends on the policy type.

Permanent life insurance and cash value

Term life insurance policies don’t come with a cash value component. But if you buy permanent life insurance, which lasts the insured’s lifetime, the policy will almost always include a cash value element.

The cash value is essentially like a savings or investment account within the policy. When you pay the policy premiums, a portion of that money gets added to the cash value account.

The life insurance premiums you pay every month get divided up. A portion goes toward the policy’s death benefit, another portion goes into the cash value account that grows tax-deferred, and yet another smaller, yet significant, a portion goes toward paying the insurer’s operating costs and fees. Since this type of life insurance includes so many more components than term life insurance, it can be anywhere between 5 to 15 times more expensive.

The money in your cash-value account is usually invested by the insurer into a conservative-yield investment so that your interest earnings will grow over the years.

Types of cash value life insurance

There are several different types of cash value life insurance policies, and each grows the cash value in a distinct way:

  • Whole life insurance cash value accounts grow at a steady, fixed rate set by the insurance provider at the time of the policy purchase. Some life insurance companies also distribute dividends to add to whole life cash value based on their company performance.

  • Variable life insurance cash value operates more like an investment account. You get to invest the cash value in the stocks, mutual funds, or bonds that you choose from the list of options provided by your life insurance provider. Your cash value grows or shrinks depending on the performance of the investments you choose.

  • Universal life insurance grows the cash value at market interest rates.

  • Indexed universal life insurance grows cash value according to the performance of specific indexes, like the Dow Jones Industrial Average. Insurance companies set a cap and a floor to limit losses and potential growth.

  • Variable universal life insurance cash value grows just like variable life insurance cash value (The difference is in how the policy is structured with regards to premiums and fees).

How to use the cash value

The cash value account within a life insurance policy is a living benefit, meaning the policy owner can use it while the insured is alive. Let’s look at a few common ways to use the cash value:

  • As loan collateral. The cash value can serve as collateral for a low-interest rate loan from the insurance company. Keep in mind, though, that if there’s any unpaid loan amount at the time of the insured’s death, the insurer will deduct that amount plus interest from the death benefit they distribute.

  • For a withdrawal. You can withdraw cash value, but doing so will decrease the policy’s death benefit proportionately. If you take out an amount that’s less than or equal to what you’ve paid into the policy in premiums, the money isn’t subject to taxes. But if you withdraw more than you’ve paid, the excess amount will be taxed as income.

  • Borrow against it. You can borrow against the cash value of your whole life insurance policy, usually at a lower rate than other loans. This type of loan is one way parents pay for their children’s college education, but it can really be used for any purpose during your lifetime, including paying for unexpected medical bills, caregiving, etc.

  • For a payout with a policy surrender. If you decide you no longer want or need the life insurance policy, you can surrender it to the insurer. At that point, they will pay you the policy’s cash value amount, minus any surrender fees, if applicable.

  • To pay premiums. If you have any type of cash value-building life insurance, you’ll most likely be able to use your cash value to pay policy premiums at a certain point. This can be helpful for people who let the cash value accrue until retirement, then pull from it once they’re on a fixed income. If you choose this option, watch your cash value amount. If you fully deplete the account, your coverage can lapse.

  • As an investment & tax-deferred growth. With whole life insurance, you don’t need to pay taxes on interest, dividends, or capital gains on the cash value. That’s one reason people choose it as their preferred investment vehicle.

When the insured dies, the cash value doesn’t get distributed to their beneficiaries. Instead, the amount remaining in the account gets absorbed by the insurance provider. However, many permanent life insurance policies offer the ability to have the death benefit grow in cohort with the cash value growth.

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