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Cash value life insurance is a form of permanent life insurance that features a cash value savings component. The policyholder can use the cash value for many purposes, such as a source of loans or cash or to pay policy premiums.
Cash value insurance is permanent life insurance because it provides coverage for the policyholder’s life. Traditionally, cash value life insurance has higher premiums than term life insurance because of the cash value element. Most cash value life insurance policies require a fixed-level premium payment, of which a portion is allocated to the cost of insurance and the remaining deposited into a cash value account.2
The cash value of life insurance earns a modest rate of interest, with taxes deferred on the accumulated earnings. Thus, the cash value of life insurance will increase over time. 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.
Consider a policy with a $25,000 death benefit. The policy has no outstanding loans or prior cash withdrawals and an accumulated cash value of $5,000. Upon the death of the policyholder, the insurance company pays the full death benefit of $25,000. Money collected into the cash value is now the property of the insurer. Because the cash value is $5,000, the real liability cost to the insurance company is $20,000 ($25,000 – $5,000).
Whole life, variable life, and universal life insurance are all examples of cash value life insurance.3
The cash value component serves as a living benefit for policyholders from which they may draw funds. The life insurance net cash value is what the policyholder or their beneficiary has left over once the insurance company deducts its fees or any expenses incurred during the ownership of the policy. There are several options for accessing funds. For most policies, partial surrenders or withdrawals are permissible but these can reduce the death benefit.
Taxes are deferred on earnings until withdrawn from the policy and distributed. Once distributed, earnings are taxable at the policyholder’s standard tax rate. Some policies allow for unlimited withdrawals, while others restrict how many draws can be taken during a term or calendar year. Some policies limit the amounts available for removal (e.g., minimum $500).
Most cash value life insurance arrangements allow for loans from the cash value. Much as with any other loan, the issuer will charge interest on the outstanding principal. The outstanding loan amount will reduce the death benefit dollar for dollar in the event of the death of the policyholder before the full repayment of the loan. Some insurers require the repayment of loan interest, and, if unpaid, they may deduct the interest from the remaining cash value.4
Cash value may also be used to pay policy premiums. If there is a sufficient amount, a policyholder can stop paying premiums out of pocket and have the cash value account cover the payment.
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Coverage and availability varies by risk type, state and insurance carrier. Not all coverages are available as specified and there are many variances among carriers.
