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If you’re in the market for a permanent policy, you may have come across the term “cash value.” It has a nice ring to it, but you’ll need to do some careful analysis to learn whether a cash-value policy is worth the cost.
What is cash value life insurance?
The phrase “cash value” refers to a savings component of permanent life insurance, such as universal life and whole life insurance. Basically, when you pay your premium, a portion goes toward funding the policy's cash value. That cash value earns interest over time at either a fixed or variable rate depending on the type of permanent policy you have. Once you’ve accumulated enough cash value, you can begin to access that money in various ways.
Which life insurance policies build cash value?
Most permanent policies build cash value, including whole, universal, variable and indexed universal life insurance.
Term life insurance does not have a cash value component, which means you can’t borrow against the policy. It provides temporary coverage for a certain period, such as 10, 20 or 30 years, and pays out if you die within the term. That’s why it’s so affordable, especially for young and healthy people. In general, term life is sufficient for most people.
» Need term life insurance? Compare life insurance quotes
How your policy earns cash value over time
How the cash value grows depends on the kind of permanent life insurance policy you buy.
A whole life insurance policy guarantees a fixed rate of return on the cash value, and policyholders with mutual companies may earn additional dividends.
With indexed universal life insurance, the cash value growth is tied to a stock or bond index, such as the S&P 500. The cash value can decrease if the indexes fall.
With variable universal life, the cash value is invested in various subaccounts of stocks, bonds or mutual funds. This kind of policy offers the greatest potential returns but comes with the risk that you could lose some cash value if the investments tank.
» MORE: Term vs. whole life insurance
What you can do with the cash
The cash value is a big selling point that insurance agents emphasize when selling permanent life insurance. Here’s what you can do with the cash value of a life insurance policy.
Make partial withdrawals. If the money is not repaid, the withdrawals will reduce the policy’s death benefit — the payment to the beneficiary when you die.
Borrow against the cash value. You can take out loans for anything you’d like. You’ll have to repay them, though, with interest — if you don’t, the insurer will subtract the outstanding loan amount from the death benefit.
Withdraw all the cash value and surrender the policy. This will end the life insurance coverage, and in the early years, you will likely have to pay a surrender fee to the insurance company.
Use it to pay premiums or the cost of insurance. Once the cash value reaches a high enough level, you might be able to funnel the money towards your whole life insurance policy premiums. For other permanent policies, you can use the cash to cover the cost of maintaining your policy.
Note that it can take years to build up enough cash value to start accessing the money within your policy.
Pros and cons of cash value life insurance
Policies earn money that can be withdrawn or borrowed against during your lifetime.
Cash value policies tend to have higher premiums than term life insurance.
Policies typically last your lifetime.
Managing policies often requires a hands-on approach.
Cash value loans have relatively low net interest rates.
Unpaid loans can reduce the death benefit paid to your beneficiaries.
» MORE: Average life insurance rates
Is cash value life insurance right for you?
Your decision to buy a cash value life insurance policy will depend on how much risk you want to assume and how much flexibility you want to have.
A whole life policy is the most straightforward permanent policy because everything is fixed and guaranteed — the annual premium you pay, the death benefit and the base return on cash value.
Universal life insurance lets you adjust your premiums and the coverage amount, within limits. The different types of universal life offer varying levels of risk when it comes to cash value growth.
If you need temporary, low-cost coverage that’s simple, you may want to consider a term life policy instead of cash value life insurance. You’ll need a trusted life insurance agent to walk you through your permanent policy options. It’s also a good idea to get a second opinion from a fee-only life insurance advisor to see whether cash value life insurance is the right type of policy for you.
Still not sure which type of life insurance is right for you? Try out our tool below.