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

stacks of coins growing in value to fill a jar of money

If you’ve looked into getting life insurance, you’ve likely heard about cash value life insurance. You may even think it’s a great deal. After all, who wouldn’t want a policy that builds cash value?

The trouble is that many people don’t understand the cost tradeoff of cash value life insurance. If cost is a concern, you may not be able to afford enough protection for your family. Policies with cash value tend to be 5x to 10x more expensive compared to other options. 

But it isn’t a great option for people looking to build wealth, either. The return you get is lower than other investment options, and you can end up paying for insurance you don’t need.

Keep reading to learn how it works and what happens to the cash value when you die.

Table of Contents

What is Cash Value Life Insurance?

The first thing you must understand about cash value life insurance is that it isn’t a policy you can buy. Instead, cash value is a component of permanent life insurance policies. When you purchase permanent life insurance, a portion of your premium payment goes to a savings account that builds cash value over time.

Types of Cash Value Life Insurance

Remember that cash value isn’t a type of life insurance — it’s just one part of a permanent policy. Permanent and term life are the two primary categories of life insurance. Term life doesn’t have a cash value component, but permanent policies do. Many types of permanent policies include cash value, such as

  • Whole life insurance
  • Universal life insurance
  • Variable and variable universal life insurance
  • Indexed universal life insurance

Each has differences that determine the rate of return, cost of premiums, what you can use the cash value for and how much of your premium goes into a savings account.

How Cash Value Life Insurance Works

Permanent life insurance with cash value works similarly to other policies in that it provides a payout to your beneficiaries when you pass away. However, permanent policies have two components: a death benefit paid to your family when you die and cash value that serves as a savings vehicle.

Your cash value account is invested and grows over time. But you have no control over how it’s invested. It comes down to the type of policy — some are indexed to different benchmarks, such as the S&P 500, and guarantee you’ll never get a negative return. 

Each type of permanent insurance will have its own rules about what they’ll invest in and what kind of return you can expect. 

Although policies can accrue cash value differently, there’s one unique feature you can take advantage of: You can use some of it while you’re still alive. Your insurance company may allow you to use the cash value to pay your premiums or take out a loan against the policy.

Face Amount vs. Cash Value in Life Insurance

To understand how cash value builds over time, you first must understand how the face amount in life insurance is different from the cash value.

  • Face value is just another name for the coverage amount purchased. It refers to the amount of money paid out when the policyholder dies.  
  • Cash value is the portion of your policy that earns interest. You may be able to access the funds or borrow against it while you’re still alive.

The death benefit is usually equivalent to the face value of the policy, but it could be less when you pass away. For example, suppose you took out a loan against your policy’s cash value. If you passed away before you repaid the balance, your insurer would reduce the death benefit by the amount of any unpaid loan and interest. In that case, the death benefit your beneficiaries receive will be less than the face value of the policy. 

How Cash Value Builds Over Time

Each time you make a payment, your premium is split into separate buckets: the policy’s death benefit, the insurer’s operating costs and profits, and your policy’s cash value.

A larger portion of your premium goes toward cash value when you first buy a policy. That’s why cash value can grow quickly during the early years of your policy. As you get older, more of the premium is needed to cover the cost of insurance, and your cash value accumulation slows down.

Let’s look at an example:

Suppose you’re 28 years old and in generally good health. Your purchase a whole life policy with a face value of $250,000. Here’s how your cash value might grow:

Policyholder Age Annual Premiums Total Premiums Paid to Date Cash Value
34
$1,941
$13,587
$8,713
35
$1,941
$15,528
$10,919
36
$1,941
$14,469
$13,231
37
$1,941
$19,410
$15,653
38
$1,941
$21,351
$18,190
39
$1,941
$23,292
$20,851

Source: White Coat Investor, based on 28 year old female in relatively good health

Keep in mind this is an extremely simple example, and the numbers that apply in your situation could be vastly different. It depends on your insurer, policy type and how the funds are invested. But it’s easy to see that cash value policies are incredibly complex. Make sure you understand how your policy works before buying life insurance coverage.

How to Use Cash Value from Life Insurance

Many people purchase a policy with cash value to use as a “forced savings account.” As you pay premiums, your insurance agency generally invests the funds. Then, as your cash value accumulates, you can use the funds in various ways.

Cash Value Withdrawals

Depending on your policy terms, you may be able to withdraw money directly from your cash value account. But be aware that the death benefit your loved ones receive when you die is reduced by how much you borrow.

Take Out a Loan

You might take out a loan to cover college tuition, home remodeling or an emergency. However, you’ll pay interest on what you borrow, despite it being your money to begin with. Your death benefit will also be decreased if you don’t pay back the loan before you die.

Surrender the Contract

You can get some of the cash value back if you surrender the policy. The process depends on your policy, but the insurer will subtract fees from the balance before it gets to you. You’ll also pay taxes on the cash value if it’s more than the premiums you’ve paid over the years.

Use It to Pay Premiums

As a policyholder, you can use the cash value to pay your policy premiums. Check with your provider first — they may charge you a withdrawal fee for this option.

Sell the Policy

If you no longer need your policy and don’t want to surrender it, you could sell it for a cash settlement. But there’s a catch: part of your settlement will be paid to the insurance agent who set you up with your policy.

What Happens to the Cash Value When You Die?

When you die, your family doesn’t get any cash value you accumulate. Even though it’s your money that you paid to build savings over time, it all goes back to the insurance provider.

Pros and Cons of Cash Value Life Insurance

Permanent life insurance with cash value seems like a good deal. You pay higher fees, but you accumulate cash value over time. However, there are several drawbacks to consider, as well. 

Pros Cons
You can borrow or withdraw from your cash value funds while you’re alive.The cash value savings earns interest.
Your death benefit decreases if you remove money from your cash value account.Your family doesn’t get the cash value when you die (the insurer takes it).The cost can be substantially higher.

Cash Value vs. Term Life Insurance

Cash value is permanent life insurance that lasts your entire life. No matter when you die, permanent life insurance can pay a death benefit. Each time you pay premiums, your payment is split between the insurance company’s operating costs and profits, the death benefit and cash value. The policy’s cash value builds over time, and you can earn interest on the funds and borrow against it if the need arises. 

When you die with a cash value policy, your beneficiaries receive a death benefit. The amount is usually the face value, but they may receive the balance of the cash value if it’s greater than the face value amount.

Term life insurance lasts for a set period, usually 10, 20 or 40 years. Term life doesn’t have a cash value component, so the fees are split between the death benefit and the company’s operating costs and profits. If you die while your term policy is active, your beneficiaries will receive the death benefit amount. Otherwise, your beneficiaries won’t get a payout because the policy is expired.

Type Insurance Company’s Operating Costs and Profits Policyholder’s Death Benefit (Face Value) Cash Value of the Policy
Permanent
x
x
x
Term
x
x

With both policy types, the company’s operating costs and profits are essentially the same. But premiums are higher for permanent insurance because you’re paying into your cash value. But think about this: It must be significantly more expensive than term because a few dollars each month won’t add up to much over time.

Jake's Take

“Permanent is significantly more profitable than term for insurers and agents, which is part of why they tend to promote it more. If it’s more valuable for them, it's probably less valuable for you.”

Jake Tamarkin, CEO of Everyday Life

Cash Value vs. Whole Life Insurance

Cash value isn’t a type of life insurance, but it can be part of a whole life policy. With whole life insurance, a portion of your premium is set aside in a savings account. You’ll earn a return on the amount, and it’ll continue to accumulate as long as your policy is active. 

When you pass away, your family can receive a death benefit minus any withdrawals or loans you may have made against the cash value.

Is Cash Value Life Insurance Right for You?

Cash value life insurance is a common type of permanent life insurance. However, cash value life insurance premiums are much more expensive than a term policy.

It’s important to look at your life insurance needs and goals before deciding which type of policy is best. There are several types of life insurance, including term and permanent coverage. Life insurance companies may offer different policy types, riders, or benefits to customize your policy within these categories.

The easiest and best way to know which type of life insurance is right for you is to use The Ultimate Life Insurance Calculator. You’ll answer a few questions and get recommendations on policies that fit your circumstances. And if we think you don’t need life insurance? We’ll tell you that, too.

Get a quote today — it’s 100% online, and no contact information is required.

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