- Some life insurance policies offer a cash value component in which a portion of your premiums go toward building a secondary type of savings account.
- Policyholders can borrow against this cash value, withdraw from it or use it to pay premiums.
- Depending on the type of policy, cash value funds can earn basic interest or even be invested.
Life insurance doesn’t just provide you with a death benefit that can help your loved ones after you die. Policies offer also sorts of other perks, including, for example, the ability to accrue cash value over time.
Here’s a look at what that cash value is exactly, which types of policies offer it and whether getting life insurance with a cash benefit is the right choice for you.
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What is a cash value benefit?
The cash value benefit of a life insurance policy is an automatic, built-in savings vehicle. This benefit directs a portion of your policy’s premiums into a dedicated savings account, where the money can then grow over time or even be invested, depending on the type of policy you have.
Cash value benefits can be used in a variety of ways. You can withdraw these funds, borrow against them in case of an emergency, or even use them to pay your policy’s premiums in the future.
Life insurance policies that offer a cash value benefit
Cash value benefits generally aren’t an option on term life policies (these policies are in effect for a set period of time, generally 10 to 30 years). In order to get the benefit, you’ll need to shop around for a permanent life insurance policy, one that lasts your lifetime as long as you pay the premium.
Permanent coverage options include:
While permanent life insurance policies may offer a cash value benefit, it isn’t guaranteed. You’ll want to be sure to read your policy’s coverages and benefits before buying, to ensure that it offers the cash value benefit you want. Note that permanent life coverage is always significantly more expensive than term life insurance.
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How cash value benefits work
When you buy a life insurance policy, you’re likely buying it with a death benefit in mind. This coverage provides your family with a cash payout if you die from a covered cause while the policy is in effect.
If you purchase a permanent life insurance policy with a cash value benefit, you’re actually getting two types of coverage: a death benefit if you pass away and a cash value benefit, which can be used while you’re living.
“The difference with cash value policies is that there's an additional ‘bucket’ from the premium that gets directed towards cash value,” says Brian Haney, founder and vice president of The Haney Company, a financial services firm in Washington, DC. “It’s not just the pure mortality expense.”
Depending on the type of policy you have, the cash value may:
Earn a predetermined annual return
Be tied to a specific index
Be invested in a variety of indices
In most cases (but not all), the cash value will compound and grow over time.
How Cash Values Grow Over Time
The older you get, the more expensive you are to insure. This is why it costs more to purchase a life insurance policy as you age, versus buying one when you’re young and healthy.
The cash value portion of your life insurance policy, if applicable, takes this into account. For instance, the first few years of your coverage, a greater percentage will go toward building your policy’s cash value. As you age, though, and the actual cost of your insurance coverage increases, more and more of your premium will go toward your life insurance coverage… and less will go toward your policy’s cash value.
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For example, let’s say that when you first take out a life insurance policy, 30% of your premium goes toward building your cash value. The remaining 70% is used to actually “pay” the insurance company for your coverage.
However, as you age and as rates increase market-wide, this ratio shifts. Eventually, you may find that only 4% of your premium is going to your cash value, while the other 96% pays for your actual coverage.
That cash value balance will grow in other ways, too. It may be in an account that accrues tax-deferred interest, for instance. Or it might be tied to a specific stock market index. While this can be a riskier option, it also allows for good potential gains.
Of course, it’s important to note that the actual percentage of premiums that go toward a policy’s cash value (and its growth over time) depend on factors like the carrier and the type of policy you purchase.
How to tap your cash value
If you own (and have been paying into) a life insurance policy with a cash value benefit, there are a few different ways you can access the money:
You can borrow against it: The rules and limits of a loan are set by the carrier, but generally, you are allowed to temporarily withdraw funds from your account. You’ll be expected to pay the debt back with interest, though it’s not considered taxable income as long as you do.
You can withdraw it: You can simply withdraw from your policy’s cash value, without needing to pay those funds back. If you withdraw only what you paid into the cash value account—or less —you don’t have to pay taxes on those funds. However, if you are also withdrawing any interest that has accrued, expect that to be taxed as income.
You can use it to pay premiums: Depending on your cash value balance and how much your life insurance coverage costs, you may be able to stop making monthly premium payments and simply use your accumulated cash value to pay for your coverage. Just be careful not to let your cash value get depleted, as your policy could lapse.
Is a cash value policy right for you?
Getting a cash value benefit typically means buying permanent life insurance coverage, which is more expensive than term life insurance. However, if permanent life insurance seems like a good fit for you, your financial needs and your budget, then this benefit can be a notable bonus.
“Cash value life insurance, designed correctly, serves as both a means of protecting your loved ones AND as an asset,” says Haney.
Before buying life insurance, ask yourself what your financial needs are, both in the short- and long-term. Consider how long your loved ones will need financial protection, what you can afford to spend on coverage, and which features are most important to you.