Key takeaways
- Permanent life insurance policies generally grow cash value that you can borrow from or withdraw for any reason.
- The way the cash value grows depends on the type of life insurance policy.
- The cash value grows tax-deferred and you can usually withdraw up to the amount you paid in premiums tax-free.
Permanent life insurance policies—such as whole life and universal life—provide a lifelong death benefit and also have a savings feature, called cash value. The cash value grows tax-deferred in the account, and you can borrow or withdraw from it for any reason, such as for a house down payment, retirement, college costs or other purposes.
How cash value grows differs by the type of permanent life insurance. Before choosing a permanent life insurance policy, it’s important to understand how the cash value grows, what fees are assessed and how you can access the money.
How does cash value life insurance work?
When you pay premiums for a permanent life insurance policy, some of the money goes toward the cost of insuring you, which is based on a range of factors, such as your age and health. Some of it pays for administrative expenses and other internal policy charges, and the rest goes to the policy’s cash value.
Depending on the type of policy, cash value can grow based on:
- A guaranteed fixed amount
- The insurance company’s investment performance
- The gains of a specific stock index
- The performance of investments you choose (such as mutual fund-like accounts)
It might take several years before your cash value starts to grow because of up-front sales expenses and administrative fees. But you can eventually access the money through policy loans or withdrawals.
Withdrawals and outstanding policy loan balances are typically subtracted from the policy’s death benefit if you pass away—both can decrease the amount of money your beneficiaries receive.
How cash value builds
The way the cash value grows depends on the type of life insurance. Most permanent life insurance policies have cash value, but some like guaranteed universal life (GUL), have little to no cash value growth.
Whole life
This type of life insurance has level premiums and a guaranteed death benefit. A whole life insurance policy’s cash value grows at a guaranteed minimum rate. Some policies, called “participating policies,” can add additional money to your cash value through dividends, based on the insurer’s annual profits. Dividends, which is a portion of a company’s net earnings that is paid to policyholders, aren’t guaranteed. But many of the best whole life insurance companies have been paying them for more than a century.
Fixed universal life
Fixed universal life (UL) insurance has adjustable premiums and a flexible death benefit. The cash value is guaranteed to grow at the rate set by your life insurance company and, depending on the insurer’s investments, the cash value growth might exceed the guaranteed rate.
Indexed universal life
Indexed universal life (IUL) has a flexible death benefit and adjustable premiums, similar to UL. However, an IUL policy’s cash value growth is based on a market index’s performance, such as the S&P 500.
You don’t receive the full return of the index. Instead, you usually have a performance cap, such as the point-to-point return of the S&P 500 up to an 8% maximum, even if the index return is higher. Or it might only credit your cash value with 80% or 90% of the index’s returns, called a participation rate. These policies usually have a 0% or 1% floor, guaranteeing that your cash value won’t lose money, even if the value of the index decreases.
Variable universal life
Variable universal life (VUL) insurance also has a flexible death benefit and adjustable premiums. The policy’s cash value growth is based on the performance of market-based subaccounts you choose, which are like mutual funds.
Gains and losses are based on investment performance, minus policy expenses. There is no cap on the investment performance, but there is also no minimum guarantee. If the investments lose value, your cash value could shrink. If the cash value isn’t enough to cover the policy’s expenses, you might have to increase your premiums or the policy could lapse.
Our analysis of investment options among 14 VUL policies found an average of 62 subaccounts to choose from, including variable and fixed options.
Comparison of cash value growth methods
When does cash value life insurance make sense?
Since only permanent life insurance policies are considered cash value life insurance, they generally are a good option if you need long-term life insurance coverage and want to build a tax-advantaged savings feature that you can access while you’re still alive.
If you don’t need long-term coverage and building cash value is not a priority, term life insurance may be a better fit. These policies provide coverage at a fixed rate for a set period, such as 10, 20 or 30 years.
How to access cash value in life insurance
You can access your cash value in a few ways.
- Withdrawals. You can withdraw some money from the cash value while keeping the policy in force. You can withdraw up to the amount you paid in premiums tax-free, but you might face income taxes on withdrawals above that level. Cash value withdrawals reduce your death benefit.
- Policy loans. You can borrow money from your cash value, often at a lower interest rate than standard loans and without requiring a credit check. If you die before paying back a cash value loan, the death benefit is reduced by the outstanding loan.
- Policy surrender. If you no longer need the life insurance policy, you can cash out, or surrender, the policy. You’ll receive the cash value, minus any surrender fees, and you’ll no longer have that life insurance coverage.
You can use money from cash value for a range of reasons, such as supplementing retirement income or using it as a down payment for a home, but it’s important to keep the consequences in mind. Withdrawals and policy loans that aren’t paid back typically reduce your death benefit, but you might not want to leave your beneficiaries with little to no life insurance payout.
Pros and cons of cash value life insurance
Consider the pros and cons of cash value life insurance before buying a policy.
What to watch out for and questions to ask your agent
Cash value life insurance policies can be complicated and you have several choices. It helps to work with an experienced life insurance agent or financial adviser who understands how these options can fit within your financial plans. Ask the following questions before choosing a policy.
1. How does the cash value grow?
Does the cash value grow at a guaranteed rate or is it tied to a market index or other investments? How much of your premiums goes toward the cost of insurance, how much to administrative expenses and how much makes it to the cash value? A policy illustration can show the projected cash value growth based on guaranteed rates and current expenses and rates, and other assumptions.
2. What are the guaranteed rates and the current rates?
If you buy a whole life or fixed universal life policy, there will be a guaranteed rate of cash value growth and you might receive more money based on the insurer’s investment performance. Before you buy a permanent life insurance policy, look at a policy illustration showing the cash value increase at the guaranteed rates and the current rates or other assumptions.
One of the factors in our ratings of life insurance companies is the reliability of policy illustrations.
3. What happens if the investments lose money?
If the underlying investments you chose in a variable universal life insurance lose money, the cash value could shrink. Some VUL policies offer a no-lapse rider, which guarantees that the policy will stay in force even if the investments decrease in value (as long as you pay a certain level of premiums).
Indexed universal life insurance policies usually have a floor of 0% or 1% and the cash value won’t fall below the floor even if the index for the IUL loses money.
4. Are there any surrender charges?
Most permanent life insurance policies have surrender charges, which are subtracted from your cash value if you cash out and end the policy in the earlier years. For example, our analysis of 14 VUL policies found surrender charges typically range from 10 to 15 years, with the amount gradually decreasing each year.