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Life insurance offers a way to provide your loved ones with financial security after your death. Some types of life insurance come with an extra benefit: cash value that you can build on and draw from during your lifetime.
There's a catch, though. If you don't use the cash value from your life insurance before you die, the money reverts to the life insurance carrier. Due to this risk, you should carefully weigh the pros and cons of a cash value life insurance policy and how you might use it before buying one.
What Is Cash Value?
There are two basic types of life insurance: term life and permanent life.
- Term life insurance lasts for a certain time period (typically 20 years). The value of term life insurance is the payout, or death benefit, that your beneficiaries receive upon your death. There's no other cash benefit.
- Permanent life insurance lasts your entire life (or to age 99, depending on the policy). Permanent life insurance has a cash value. This cash value life insurance puts part of your premium payments into a cash value account that earns tax-deferred interest at a rate guaranteed by the insurance carrier (usually 1% to 2%). Ultimately, the cash value in your policy can equal or surpass the policy's face value.
What can you do with your insurance policy's cash value? You may have several options, depending on your insurance policy's terms:
- Borrow from it when you need money
- Surrender the policy in return for the cash value
- Use the cash value to pay the premiums
- Use it to boost your death benefit
Of course, you can also leave the cash value to grow. Just be aware that at your death, the cash value typically returns to the insurance company, not to your heirs.
What Happens to Cash Value at Death?
Whole life and universal life are the two main types of permanent life insurance. While both kinds of insurance have cash value, there are some important differences between them.
Whole life insurance:
- Your coverage and premiums stay the same for the life of the policy.
- Any cash value in the policy at your death is forfeited to the insurer.
Universal life insurance:
- You can modify your coverage and premiums if you wish. For instance, you might choose to reduce your coverage if your needs change.
- Some universal life policies give you the option to add the cash value to the death benefit your beneficiaries receive. However, doing so will generally increase your premiums. Since permanent life insurance is already much pricier than term life insurance, you may not want to add to your costs.
How to Access Your Cash Value
Depending on your specific insurance policy, you may be able to access your cash value in several ways.
- Withdraw money. You can typically withdraw money from the cash value in your life insurance policy without paying taxes on it—as long as the amount withdrawn doesn't exceed the amount you've paid in premiums thus far. You might withdraw cash value to pay off your mortgage, finance a child's college tuition or pay for nursing home care as you age.
- Surrender the policy. Withdrawing the policy's entire cash value cancels the policy. This is called surrendering the policy. You might want to surrender a policy if your beneficiary has passed away or no longer needs the death benefit. A policy's cash surrender value is the amount you've paid in premiums plus any accrued interest, minus any outstanding loans or unpaid premiums. You may also have to pay surrender fees or income taxes on the cash surrender value.
- Take out a loan. There's no need for a credit check when you borrow from your own insurance policy's cash value. In fact, you don't even have to repay the loan. However, interest continues to accrue; if the interest grows to surpass your cash value, your policy may lapse. Also be aware that any unpaid loans, interest and fees will be subtracted from your death benefit, reducing the amount your beneficiaries receive.
- Use it to pay your insurance premiums. Once your cash value reaches a certain amount, you may be able to use it to pay your insurance premiums. Money you would have used to pay the premiums can be invested, potentially earning higher returns than your life insurance policy would. Just keep tabs on your cash value: If it dwindles so much that it can't cover your premiums, your policy could lapse.
- Use it to increase your death benefit. Some permanent life insurance policies allow you to trade your cash value for a higher death benefit. If you don't need the cash value in your policy yourself, this could be a way to leave more money to your loved ones.
Is Cash Value Life Insurance Worth It?
Buying life insurance that builds cash value may sound like an easy way to make money. But cash value life insurance is significantly pricier than term life insurance—up to 15 times as expensive. Building up cash value takes time; borrowing or withdrawing that money could reduce your beneficiaries' death benefit or incur income taxes. Finally, the returns on cash value in a life insurance policy generally won't match those from investing in a 401(k) or IRA plan. You might be better off purchasing term life insurance and investing the money you would have spent on cash value premiums.
Cash value life insurance might make sense if you've already maxed out other investment vehicles. Consulting a financial advisor can help you decide how a cash value life insurance policy might fit into your long-term financial plans. Also consider signing up for free credit monitoring from Experian. Maintaining a good credit score should be part of your strategy for a secure retirement.