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While the core purpose of any life insurance is to financially protect your loved ones if you pass away, cash value life insurance operates a bit differently than its term life counterpart by developing an accessible savings component during your lifetime.

In today's ever-changing financial landscape, knowing all your options is an important part of understanding how to buy life insurance that fits your goals and budget. Here are the basics of how cash value life insurance works, the pros and cons to consider, and tips for determining whether cash value life insurance makes sense for your particular situation.

What types of life insurance have cash value?

There are a few types of life insurance policies that offer cash value. These types of policies differ from term life insurance, which does not have a cash value component.

  • Whole life insurance offers a fixed premium and guarantees a minimum death benefit. It also has the potential to accumulate cash value over time through investments made by the insurer. This type of policy may be a good option for those looking for lifelong insurance coverage with the added benefit of building cash value.
  • Universal life insurance also offers a death benefit and a cash value component, but it differs from whole life insurance in that it allows for more flexibility in premium payments and potential adjustments to the death benefit. It also typically has higher fees and expenses compared to whole life insurance.
  • Indexed universal life insurance is a type of universal life insurance that has cash value growth potential tied to an index (such as the S&P 500®), while also typically having some limits on growth and protecting against losses.

Term life insurance is different from permanent life insurance and does not have any cash value component. This type of insurance provides coverage for a specific term (usually 10 to 30 years) with fixed premiums. Once the term expires, there is no cash value or payout from the policy and no value other than a death benefit.

How does cash value life insurance work?

With cash value life insurance, a portion of your premium payments are invested into various assets, such as stocks, bonds or mutual funds, by the insurance company. The value of the money invested by the insurance company then accumulates over time and builds cash value within the policy. The cash value grows tax-deferred and can be accessed during your lifetime through withdrawals or loans.1

As the investments grow, so does the cash value of your policy. This means that in addition to providing a death benefit to your beneficiaries upon your passing, the policy also has a savings component that can be used while you're still alive. If you accumulate enough funds in your cash value account, you may be able to use that money to cover the cost of your premium.

Can I withdraw cash value from a life insurance policy?

Withdrawing cash value from your life insurance policy is relatively simple. There are three main ways to access the cash value:

  • Surrendering the policy is the most common way of withdrawing cash value from a life insurance policy. When you surrender your policy, you cancel it and receive the accumulated cash value as a lump sum.
  • Taking out a loan against your cash value is allowed by some life insurance policies. This means you're borrowing money from the insurance company, using your policy's cash value as collateral. Keep in mind that this will reduce the death benefit of your policy and any outstanding loans at the time of your death will be deducted from the death benefit.
  • Making partial withdrawals may be an option, depending on the type of life insurance policy you have. This means you can take out a portion of the accumulated cash value without surrendering the entire policy.

There are several ways in which you can use the cash value accumulated in your policy:

  • Withdrawals: Policyholders can withdraw money from their cash value at any time, for any reason. This can be useful in times of financial need or for planned expenses such as a down payment on a house. However, withdrawing money from the policy will reduce the amount of money left in the death benefit.
  • Loans: Another option is to take out a loan against your cash value. You will have to repay the loan with interest, and if you don’t, the amount owed will be deducted from your death benefit payout upon your passing. It's also important to note that taking out a loan against your cash value may affect the growth of your policy.
  • Premium payments: Some life insurance policies allow you to use the cash value to pay for premiums once you accumulate enough cash value.
  • Surrender your policy: You can withdraw all of the cash value and end your policy. Doing this will eliminate your coverage and also may require you to pay a surrender fee.

Is cash value life insurance taxable?

The cash value component of a life insurance policy grows tax-deferred. This means that you won't owe any taxes on the growth until you actually withdraw it.2 However, the way in which this cash value is taxed depends on how and when you access it. Here are some examples of how cash value may or may not be taxed:

  • Scenario 1: Surrendering the policy
    In this scenario, you decide to surrender your policy and take out all of the cash value. The amount that exceeds your premiums paid into the policy is considered taxable income.
  • Scenario 2: Taking out a loan on your policy
    Some life insurance policies allow you to take out a loan against your cash value. This is not considered taxable income.
  • Scenario 3: Withdrawing partially or fully
    Similar to surrendering your policy, withdrawing from the cash value component partially or fully will result in taxes on the amount that exceeds your premiums paid into the policy.
  • Scenario 4: Using cash value to pay premiums
    If you've accumulated enough cash value, you may be able to use it to pay off your premium payments. This is not considered taxable income.

Is cash value life insurance a good investment?

Cash value life insurance can help you grow savings alongside a death benefit. It also allows you the potential of earning dividends. Additionally, you can add riders for extra coverage to help take care of your long-term care and other medical needs. You can also qualify for certain tax advantages with a cash value life insurance policy because the cash value accumulates on a tax-deferred basis. Plus, if you borrow money from your policy, you aren’t required to pay taxes on the loan.

However, cash value life insurance may not necessarily be the best investment option for everyone. First and foremost, the premiums tend to be higher compared to term life insurance. This means you may end up paying more in premiums over time than what your policy's death benefit is worth.

Additionally, the returns on the investment portion of cash value life insurance are often lower compared to other types of investments such as stocks or mutual funds. This can limit your potential for growth and may not be suitable for those looking to maximize their returns.

It's also important to note that cash value life insurance can take several years to build a significant amount of cash value. If you were to cancel your policy early, you may receive only a fraction of what you paid in premiums back.

Consider getting cash value life insurance

Cash value life insurance offers a unique combination of protection and savings that can greatly benefit you and your loved ones. With the potential to grow tax-deferred and provide versatile access to funds, this type of policy allows for greater financial flexibility during your lifetime. However, as with any important decision, it's important to weigh the pros and cons and consider your individual circumstances before deciding whether cash value life insurance is right for you. Discuss cash value life insurance with your financial professional, or have a conversation with one of our licensed specialists.

Need help navigating life insurance?
Talk with one of our life insurance specialists today. Call 1-866-207-9160 or schedule a call.

[1] "What Is Cash Value in Life Insurance? Explanation With Example," Julia Kagan, investopedia.com/terms/c/cash-value-life-insurance.asp (May 12, 2023).

[2] "What Is Cash Value Life Insurance?" Ashley Kilroy, forbes.com/advisor/life-insurance/cash-value-life-insurance/ (Oct. 16, 2023).