The primary purpose of life insurance is to provide final expenses and protect beneficiaries from loss of income or debt burden in the event of a family member's death.

However, a permanent life insurance policy can build cash value that can be tapped for use at retirement or in case of emergencies. Whole life insurance and variable universal life (VUL), if properly funded, both deliver the means to accumulate cash that can be accessed when needed via policy loan provisions or direct withdrawals. We discuss both below.

Whole Life Policies

Whole life policies are typically among the most expensive policies to purchase. How an insurance company determines your premiums are based on the age and health of the applicant, whether the insured uses tobacco, and other factors.

As a rule of thumb, younger policyholders pay smaller premiums than older insureds. A 25-year-old male nonsmoker might pay about $900 annually for a policy with a $100,000 death benefit, whereas a 40-year-old male smoker might expect to pay $1,800 per year for the coverage. Part of the annual insurance premium charged is applied toward the pure cost of insurance, commissions, and administrative costs, while the balance is left to grow at fixed interest rates determined by the issuer.

In the first few years of a whole life policy, cash values accumulate slowly. It takes several years (especially with interest rates at historic lows) to reach a breakeven point, when total premiums paid equals the cash surrender value of the policy. At any point in time, however, the equity in the policy can be accessed by loan or withdrawal. Level premiums established at the time of issuance may also be enhanced by the payment of annual dividends from a mutual insurance company whose policyholders share in ownership.

In addition, some policies offer paid-up additional insurance options that allow policyholders to contribute additional dollars, increasing the death benefit and earning interest. Unabated, whole life cash values can grow to considerable sums, largely dependent on the number of years that premiums are paid and the internal rate of return offered by the insurance carrier.

Variable Universal Life (VUL)

Policyholders with an appetite for risk can opt for a variable universal life insurance policy. These contracts allow flexible payments and offer the availability of a separate account in which premiums are invested in mutual funds.

Unlike whole life policies, cash values invested in the separate account are neither fixed nor backed by the financial strength of the insurer. Rather, funds directed toward mutual fund sub-accounts are subject to investment risk. The primary advantage of VUL policies stems from participation in equity or debt markets, which over time may outperform fixed rates determined by the insurance company.

Compared to whole life policies that may credit premiums with a 4% interest rate, cash values grow faster in a VUL equity portfolio that annually averages a 7% return over the life of the policy. A 30-year-old female nonsmoker can contribute $100 per month to a whole life or VUL policy for 35 years. The difference in accumulated cash value is substantial if the VUL sub-accounts manage to outpace the fixed interest rate credited to whole life premiums. Without considering policy and insurance costs, the difference in accumulated value of regular $100 monthly contributions over a 35-year period would amount to more than $85,000 if the VUL portfolio averaged a 7% return, while the fixed option averaged 4%. Lengthy time horizons and moderate risk tolerances behoove policyholders who wish to utilize VUL policies as a supplemental cash-accumulation vehicle.

The Bottom Line

Whole life insurance and variable universal life are two types of permanent life insurance policies that, when properly funded, help policy holders to accumulate cash that can be accessed later in life. A whole life insurance policy will build cash more slowly. With low interest rates, it can take several years to reach the point when the total premiums paid equals the cash surrender value of the policy. On the other hand, variable universal life insurance offers the chance to build cash value faster by exposing policy holders to riskier equity and debt markets.