What is the Cash Value of Life Insurance?

We’ve written much in recent history about the different types of life insurance one can obtain. In this article, we thought we might dive deeper into one of the key aspects of some forms of life insurance. In certain types of life insurance policies, such as whole life insurance and universal life insurance, there is a component known as the cash value. Let’s explore this in detail:

Cash Value in Whole Life Insurance

Whole life insurance is a type of permanent life insurance that provides coverage for the entire lifetime of the insured person. A portion of the premium payments made by the policyholder goes into a savings or investment account, which is called the cash value. Here are the key points to understand about the cash value component in whole life insurance:

1. Savings and Investment: Part of the premium paid by the policyholder is invested by the insurance company. Over time, this investment grows, and the policyholder is credited with a portion of the returns. This accumulated amount is the cash value.

2. Tax-Deferred Growth: The cash value in a whole life insurance policy grows on a tax-deferred basis. This means that the cash value accumulates without being subject to income taxes as long as it remains within the policy. Policyholders can generally access this cash value through loans or withdrawals, and these transactions might have tax implications.

3. Policy Loans: Policyholders can borrow against the cash value of the policy. These loans typically have a low-interest rate and do not require a credit check. However, it's important to note that outstanding loans and interest can reduce the death benefit if not repaid.

4. Surrender Value: If the policy is surrendered (canceled) by the policyholder, they receive the cash surrender value, which is the cash value minus any surrender charges or fees imposed by the insurance company.

Cash Value in Universal Life Insurance

Universal life insurance is another type of permanent life insurance that offers more flexibility in premium payments and death benefits. Here’s how the cash value works in universal life insurance:

1. Flexible Premiums: Policyholders can adjust the premium payments and the death benefit amount within certain limits, providing flexibility to adapt to changing financial situations.

2. Interest-Earning Account: Similar to whole life insurance, a portion of the premium goes into an interest-earning account. The interest credited to this account is usually based on market rates or a rate set by the insurance company.

3. Policy Charges and Expenses: The insurance company deducts policy charges, cost of insurance, and other expenses from the premium and the cash value. The remaining amount continues to grow with interest.

4. Loans and Withdrawals: Policyholders can take loans or make withdrawals from the cash value. Loans must be repaid with interest, and unpaid loans can reduce the death benefit.

5. No-Lapse Guarantee: Some universal life policies come with a no-lapse guarantee, ensuring the policy remains in force as long as the cash value is sufficient to cover the cost of insurance and other charges, even if the cash value decreases due to loans or withdrawals.

In summary, the cash value component in certain types of life insurance serves as a savings or investment feature that policyholders can access during their lifetime. It offers financial flexibility and can be a source of funds for emergencies, education, retirement, or other financial needs. However, policyholders should carefully consider the terms and conditions, including the impact of loans and withdrawals, before accessing the cash value to ensure it aligns with their long-term financial goals.

*This post does not represent financial/legal advice.