Table of Contents

What Is Cash Value in Life Insurance? Explanation With Example

By

Julia Kagan

Updated February 24, 2024

Reviewed by

Charlene Rhinehart

Fact checked by

Ariel Courage

What Is Cash Value Life Insurance?

Cash value life insurance is a form of permanent life insurance—lasting for the lifetime of the holder—that features a cash value savings component. The policyholder can use the cash value for many purposes, including borrowing or withdrawing cash from it, or using it to pay policy premiums.

Key Takeaways

Permanent life insurance policies such as whole life and universal life can accumulate cash value over time.
Cash value life insurance is more expensive than term life insurance.
Unlike term life insurance, cash value insurance policies don't expire after a specific number of years.
You may borrow against a cash value life insurance policy.
You may also withdraw cash from the policy, but this will reduce the death benefit.

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How Cash Value Life Insurance Works

Cash value insurance is permanent life insurance because it provides coverage for the policyholder’s life. Usually, cash value life insurance has higher premiums than term life insurance because of the cash value element. A portion of each premium payment is allocated to the cost of insurance and the remainder deposited into a cash value account.

The cash value of life insurance earns interest, and taxes are deferred on the accumulated earnings. While premiums are paid and interest accrues, the cash value builds 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.

Example of Cash Value Life Insurance

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 accumulated in the cash value becomes the property of the insurer.

Because the cash value is $5,000, the real liability cost to the life insurance company is $20,000 ($25,000 – $5,000).

Note

Whole life, variable life, and universal life insurance are all examples of cash value life insurance. Term insurance is not cash value insurance.

Accessing the Cash Value of Life Insurance

The cash value component serves as a living benefit for policyholders from which they may access funds. There are several ways to do that.

Withdrawals

For most policies, partial surrenders or withdrawals are permissible, though these reduce the death benefit. 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., a maximum of $500).

If you withdraw more than the amount you’ve paid into the cash value, that portion will be taxed as ordinary income.

Policy Loans

Most cash value life insurance arrangements allow for policy loans from the cash value. 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 full repayment of the loan.

Premium Payments

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.

Why Consider Cash Value Life Insurance?

Policyholders of permanent life insurance have the ability to borrow against the accumulated cash value, which comes from regular premium payments plus any interest and dividends credited to the policy.

Should I Look Into Buying a Cash Value Life Insurance Policy?

Those looking to build a nest egg over a time horizon of several decades may want to consider cash value life insurance as a savings option, alongside a retirement plan like an IRA or 401(k). Be aware that cash values often don't begin accruing until two to five years have passed. And you may have to wait several years to access the cash value, or pay a penalty.

Are Cash Value Policy Premiums High?

Yes, cash value policy premiums are typically higher than regular life insurance because part of your payment goes toward savings.

What Happens When You Withdraw Cash From Life Insurance?

If you make a withdrawal from the cash value in a life insurance policy, the death benefit will decrease. If you withdraw everything, the policy terminates.

Withdrawing money from life insurance is tax-advantaged in that the IRS considers your withdrawals a return of the premiums you paid for the policy. So you can withdraw that amount of money without paying taxes. Any gains from dividends or interest, however, would be taxed—but these would not occur until after you've withdrawn all your premium payments.

The Bottom Line

Cash value life insurance provides a mechanism for policyholders to accumulate funds for future use. A portion of each premium is deposited into an interest-bearing savings account and the cash value grows tax-free over the lifetime of the deposit. This cash can be accessed for a variety of purposes during the insured’s lifetime.

Article Sources

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