Understanding Cash Value in Life Insurance Policies

Life insurance policies usually provide not only a death benefit; but also cash value, or interest, that you can collect during your lifetime. Cash value is the portion of a life insurance policy that earns interest, and you can access it at any time to pay for premiums, fund retirement, raise the death benefit, or use it for other purposes.

Depending on the type of policy you have, and the specific life insurance provider, there are various methods in which cash value might build up in your life insurance policy. Generally, cash value begins to accrue after the first year of the coverage. Your specific policy type will determine the speed at which the cash value increases.

How Cash Value Builds Up

Before you purchase your life insurance coverage, it’s important to understand how your policy generates cash value and your options for the account’s potential growth. Generally, a percentage of the premiums you pay over an extended period of time go toward building up a tax-deferred cash value account. If your finances are in order and you have extra money available, you may choose to raise your premiums in order to speed up the cash value's increase.

When you make a premium payment for cash value life insurance, it goes three places:

Into the policy’s cash value.
To the insurer’s cost providing the death benefit.
Toward life insurance company fees and charges.

Over the course of 15 or 30 years, cash value policies can gain a significant amount of value. If you purchase a cash value policy before the age of 35 and are in excellent health, you can accumulate a sizable nest egg that you can utilize as needed. As the life insurance cash value increases, the insurance company’s risk decreases, because the accumulated cash value offsets part of the insurer’s liability.

Which Life Insurance Policies Offer Cash Value

Whole life insurance and universal life insurance are two permanent life insurance types that come with the cash value feature. Term life insurance has no cash value. Each policy type accrues cash value differently, but in all cases, you can get to your cash value through a policy loan, withdrawal, or surrender of the policy. If you're thinking about purchasing cash-value life insurance, you need to understand how they differ from one another.

While universal life insurance policies increase their cash value at a rate more reliant on the market (but with a guaranteed minimum rate), whole life insurance policies build their cash value via a fixed interest rate. As a result, whole life insurance is generally more expensive than other types of life insurance policies. Cash value in variable life insurance policies can be invested in mutual fund-style portfolios, which change based on the performance of the underlying accounts. The least dangerous option is a cash value that rises at a fixed rate; this means that variable life insurance policies have the highest chance of losing money.

If you're thinking about using some of the cash value from your life insurance policy, it is highly recommended that you discuss your alternatives with your insurance agent or a financial expert. You should know how utilizing cash value can impact your policy and benefits.

The Advantages of Cash Value

The following are the main advantages of cash value:

Cash value life insurance is a combination of two distinct tools for financial planning. It offers both a tax-deferred savings account and permanent life insurance.
It provides access to funds throughout the duration of your life.
Death benefits are usually exempt from probate and come with no taxation.
Cash value grows tax-deferred.
Depending on the type of policy you have, the cash value of your policy may be used to pay premiums.
According to the terms of the insurance, you will also have the option to borrow or withdraw cash value.
A portion of your premium funds an integrated savings or investment account with cash value.
With cash value life insurance, you will have the ability to access savings later in life.

The Disadvantages of Cash Value

Compared to term life insurance, cash-value life insurance is more expensive.
Beneficiaries typically do not receive cash value.
Should you choose to take out the cash value or surrender value and stop the policy, the amount that originated from interest or investment gains may be subject to taxation.
Over time, inflation may surpass the cash value portion of a life insurance policy.
Investment alternatives for the cash value may be restricted based on the type of policy.
The policy usually includes a ceiling, which limits the annual growth of the cash value.

Is It Time to Purchase a Cash Value Life Insurance Policy?

How much risk you are willing to take on and how much flexibility you want will determine whether or not you purchase a cash-value life insurance policy. Here are a few instances where clients would benefit from cash value insurance:

For those who have already maxed out other tax-advantaged savings vehicles, such as an IRA or 401(k), a cash-value life insurance policy is the best option.
A person who is interested in diversifying their investment portfolio and requires life insurance would find this kind of policy appropriate.
It may also be beneficial for people who have long-term life insurance needs, such as covering funeral costs or supporting a dependent kid with special needs.

You may always review your life insurance alternatives and choose the best type of policy for you with the assistance of a qualified insurance agent or independent financial counselor.

The Bottom Line

Cash value life insurance might be a wise savings choice for individuals who want to accumulate money over several decades, in addition to retirement plans such as an IRA or 401(k). Yes, because a portion of your premium goes toward savings, cash value policy rates are usually greater than those for standard life insurance. Nonetheless, acquiring cash-value life insurance will give policyholders a way to save money for unexpected expenses.