Cash value life insurance encompasses several types of life insurance that contain a cash value account. This cash value component generally earns interest or other investment returns and grows tax-deferred. Term life insurance has no cash value. Types of cash value life insurance include whole life and universal life insurance. Term life insurance policies have no cash value.

You have several options if you want a life insurance policy with cash value. Each policy type accumulates cash value differently, but in every case, you can access your cash value through a policy loan, withdrawal, or policy surrender.

How Cash Value Life Insurance Works

Cash value life insurance can provide lifetime coverage. When the insured person dies, a death benefit is paid to beneficiaries, provided premiums have been paid.

When you make a premium payment for cash value life insurance, it goes to three places:

1. Into the policy's cash value.
2. Toward the insurer's cost of providing the death benefit.
3. Toward the life insurance company's fees and charges.

Only part of what you pay becomes cash value. The portion going into your cash value account grows based on a fixed amount and/or investment returns. Only part of your premium payments becomes cash value.

If you accumulate enough money in your cash value account, you may be able to use it to cover premium payments. If you are struggling to make payments, this option could provide some relief so you can keep your life insurance in force. Speak with your insurance agent to find out which rules apply.

An important aspect of cash value life insurance is Section 7702 of the tax code. This provision sets guidelines for how much money can be paid into the policy's cash value component without losing its tax-deferred status. If the amount directed to cash value exceeds these limits, it may be subject to tax.

Types of Cash Value Life Insurance

When it comes to cash value life insurance, there are several policy types to choose from. Understanding their differences is essential if you are considering purchasing cash value life insurance.

Whole Life Insurance

Whole life insurance offers a fixed monthly premium, a fixed cash value growth rate, and a guaranteed death benefit amount. Because of these guarantees, whole life insurance is usually more expensive than other life insurance options.

Guaranteed Issue Life Insurance

This is a type of whole life insurance that requires no medical exam or health questions. You cannot be turned down.

Guaranteed issue life insurance may include cash value, but because coverage amounts are generally small, the potential cash value is also small. It usually has a graded death benefit, under which beneficiaries will not receive the full payout if the insured person dies within two or three years of purchasing the policy, unless death results from an accident.

Guaranteed Universal Life Insurance.

This type of universal life insurance has fixed premiums and death benefit amounts and generally minimal cash value accumulation.

Indexed Universal Life Insurance

Indexed universal life insurance links cash value growth to gains and losses in an index such as the S&P 500. You can generally adjust premiums and death benefits within certain parameters.

Variable Universal Life Insurance

With variable universal life insurance, your cash value growth is tied to subaccounts containing investments you choose, generally bonds and mutual funds. However, you could lose cash value depending on the performance of your chosen investments. You can generally adjust your premium and death benefits within established limits.

Pros and Cons of Cash Value Life Insurance

Whether cash value life insurance is right for you depends on why you want a policy.

Benefits of Cash Value Life Insurance

• Your beneficiaries receive a death benefit. Cash value life insurance is a permanent life insurance policy, meaning it can stay in force until you die, as long as you pay the premiums due.
• Participating life insurance policies pay dividends. Many whole life insurance policies are “participating,” meaning you may receive life insurance dividends if the policy is issued by a mutual insurance company. Dividends can be taken in cash, added to cash value, used to pay premiums, or used to purchase “paid-up additions” that increase your death benefit amount.
• You can add riders for additional coverage. One of the most common life insurance riders is an accelerated death benefit, often included automatically at no additional charge. Similar riders, available for an extra charge, for chronic illness, critical illness, and long-term care allow you to access your own death benefit if you develop certain medical conditions.
• Cash value life insurance offers tax advantages. Your cash value accumulates tax-deferred, so as it grows, the IRS does not take a share. If you borrow against the policy, you also will not have to pay taxes on the loan. When you die, your life insurance beneficiaries receive the death benefit tax-free, as with all life insurance payouts.

Drawbacks of Cash Value Life Insurance

• Cash value life insurance costs more than term life insurance. If you do not need insurance for your entire life and are not interested in building cash value, term life insurance will provide the most coverage for your money.
• Cash value can take time to build. Some policies take a long time to accumulate significant cash value. You could wait many years before having access to a substantial amount.
• In most cases, cash value is not paid to beneficiaries. When you die, cash value generally reverts to the life insurance company. Your beneficiaries receive the policy's death benefit amount minus the cash value loans and withdrawals you took.
• Your policy could lapse if you borrow too much. If you take policy loans or withdrawals, you must also make sure to maintain a minimum cash value level, or your policy could lapse.
• Taxes may apply. If you withdraw cash value or take the surrender value and terminate the policy, you may owe taxes on the portion of the money that comes from interest or investment gains.

Ways to Use a Cash Value Life Insurance Policy

There are several ways to use your life insurance policy's cash value component while you are alive.

• Take out a loan. You can borrow against a permanent life insurance policy's cash value and use the money for anything you choose: an emergency, supplemental retirement income, or something else. Your loan amount accrues interest until it is fully repaid. State law may dictate the maximum interest rate for policy loans. For example, in California, insurers cannot charge more than 8% annually.
• Withdraw money from cash value. When the amount you withdraw includes investment gains, often called the "above-basis" portion, that portion is taxable as income. A withdrawal reduces your beneficiaries' future life insurance payout.
• Surrender the policy for cash. Canceling life insurance is known as surrendering your policy. When you do this, you receive the cash value minus any surrender charge. The insurance company also subtracts unpaid premiums or outstanding loan balances.