What is cash value life insurance?

How does cash value life insurance work?

A cash value life insurance policy effectively has two main parts: the death benefit, which is payable in full, from the first day the policy is in effect, and a cash value that grows over time.

When you pay premiums, a portion of your payment goes toward covering the cost of insurance (i.e., the death benefit) plus any administrative fees and other policy expenses. The remaining portion can help grow your cash value based on how much you pay in, and investment performance based on the type of policy you have (see above).

Cash value life insurance is tax-efficient — which means it helps your money grow faster because interest and investment earnings on the cash value aren’t taxed. Like other types of financial vehicles, it takes a little while for your money to grow into a usable sum. Still, once that happens, there are a variety of ways to access policy cash to help you achieve financial goals, such as paying for a child’s college tuition, starting a business, or supplementing your retirement income.

How can you cash out or take advantage of cash value?

A cash value life insurance policy gives you several ways to access the cash value you've accumulated. Before doing so, you should talk to your financial professional and a tax advisor to determine the best choice for you.

1. Withdrawals: Policyholders can make partial withdrawals from the cash value, which are generally tax-free up to the amount of the premiums paid. Any additional withdrawals may be subject to taxes or penalties, depending on the policy and the amount withdrawn.

2. Loans: Policyholders can take out a loan against the cash value, using the policy as collateral. Loans can provide access to funds without triggering immediate taxes or surrender charges. However, outstanding loan balances will typically reduce your death benefit if not repaid.

3. Surrender: Surrendering the policy involves canceling the coverage and receiving the cash value accumulated in the policy. This option may trigger surrender charges by the insurance company, particularly if you cancel in the early years of the policy.

4. Paying Premiums: In most cases, the cash value can be used to pay premiums. This can be useful if you want to reduce expenses – for example after you retire – but still wish to maintain full coverage.

When is cash value life insurance a good choice?

The decision to purchase this type of policy depends on your individual circumstances and financial goals. Here are some things to consider if you’re trying to decide if it’s a good fit for you:

1. Long-term financial strategies

A cash value policy can serve as a key component of your long-term financial strategy, providing both protection and potential savings for retirement or other financial needs.

2. Estate planning

If you have substantial assets and wish to pass them on to your beneficiaries while avoiding the delays and uncertainties of the probate process, a cash value policy can be an effective tool. You may also realize certain tax advantages, but you should consult with your tax advisor first.

3. Coverage doesn’t end

If you need life insurance coverage for your entire lifetime rather than a specific term, cash value life insurance policies such as whole life insurance can provide a guaranteed death benefit payout – at a predictable cost – for as long as it is needed. This can be essential in certain situations, such as if you want to provide for a special needs child after you're gone.

4. Supplement retirement income

These policies can be used to help supplement income for retirement, especially if you have maxed out other tax-advantaged retirement accounts such as IRAs.

Cost considerations

Permanent, cash value life insurance has many compelling advantages and a few disadvantages when compared to the most common alternative -- term life -- which can lower your life insurance cost. That cost difference exists for a number of reasons. Term life provides limited, temporary protection, and statistically speaking, you may never get a payout if you outlive the term. Permanent life insurance provides life-long financial protection, and assuming the policy is kept in force, an eventual payout is guaranteed. Term life has no cash value: you pay premiums for, say, ten or 20 years, and after the term is over, you generally get nothing back. Furthermore, you're no longer protected once the term ends (and if you want to continue protection, you need to reapply for coverage, typically at a significantly higher cost). Permanent life insurance builds tax-deferred cash value that can be accessed in a variety of ways while you're still alive. And there are no contribution limits, and you can access funds before retirement age.

How much will a cash value policy cost? A number of factors go into determining rates, including age, gender, health status, and coverage amount, but as an example, a healthy 30-year-old non-smoking female can get a $100,000 whole life policy for about $80/month. A universal life policy could cost even less, but only whole life insurance has guaranteed level premiums that don’t increase over time. It provides life insurance protection that can’t be canceled by the insurance company, regardless of how old you get or whatever occurs to affect your health. 

Is cash value life insurance right for you?

Permanent life insurance that builds cash value can be a powerful financial tool to help protect your family and lifestyle. But there are a lot of good options to choose from, and your situation is unique, so it helps to get guidance from a professional who can tailor a policy to your needs and get a meaningful quote. Now would be a good time to discuss your situation with a financial professional who has helped others get life insurance protection. If you don't know such a person, ask friends or colleagues for a recommendation. Or, Guardian can connect you to a Financial Professional who can help.