Understanding what cash value life insurance is and how it works can help determine whether it is right for you.

Cash value is a component of certain life insurance types. It is typically offered within permanent policies, such as whole life and universal life insurance. The cash value can function as an investment-like savings account from which you can withdraw money.

Cash value life insurance includes several types of life insurance containing a cash value account. This component generally earns interest or other investment returns and grows tax-deferred.

If you want a cash value policy, you have several options. Each accumulates cash value differently, but in every case, you can access it through a loan, withdrawal, or policy surrender.

How cash value life insurance works

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

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

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

Only part of what you pay therefore becomes cash value. The portion entering your cash value account grows based on a fixed amount and/or investment earnings.

If sufficient cash value accumulates, you may be able to use it to pay premiums. If payments are difficult, this option could provide relief and keep coverage in force. Ask your insurance agent which rules apply.

An important aspect of cash value life insurance is tax code Section 7702. It establishes guidelines for how much money can be paid into the policy's cash value component without losing tax-deferred status. Amounts exceeding these limits may be taxable.

Types of cash value life insurance

Several policy types are available. Understanding the differences is essential if you are considering cash value life insurance.

• Whole life insurance: Whole life offers a fixed monthly premium, a fixed cash value growth rate, and a guaranteed death benefit. Because of these guarantees, whole life insurance usually costs more than other life insurance options.
• Guaranteed issue life insurance: This type of whole life requires no medical exam or health questions. You cannot be turned down. It may include cash value, but because coverage amounts are generally small, potential cash value is small. It usually has a graded death benefit: beneficiaries do not receive the full payout if the insured dies within two or three years of purchase, unless death is accidental.
• Guaranteed universal life insurance: This universal life type has fixed premiums and death benefits, generally with minimal cash value accumulation.
• Indexed universal life insurance: Links cash value growth to gains and losses in an index such as the S&P 500. Premiums and death benefits can generally be adjusted within specified parameters.
• Variable universal life insurance: Cash value growth is linked to subaccounts containing investments you choose, usually bonds and mutual funds. You could lose cash value depending on those investments' performance. Premiums and death benefits can generally be adjusted within established limits.

Advantages and disadvantages of cash value life insurance

Whether cash value life insurance suits you depends on why you want a policy.

Benefits of cash value life insurance

• Beneficiaries receive a death benefit. Cash value life insurance is permanent coverage, meaning it can remain in force until death as long as required premiums are paid.
• Participating life insurance policies have dividends. Many whole life policies are participating, meaning they may pay life insurance dividends when issued by a mutual insurer. Dividends can be taken in cash, added to cash value, used to pay premiums, or used to buy paid-up additions that increase the death benefit.
• You can add riders for extra coverage. One of the most common life insurance riders is an accelerated death benefit, often included automatically at no extra charge. Similar riders for chronic illness, critical illness, and long-term care carry additional charges and allow access to your death benefit if you develop specified medical conditions.
• Cash value life insurance offers tax advantages. Cash value accumulates tax-deferred, so the IRS does not take a share as it grows. Borrowing against the policy also does not require paying tax on the loan. Upon death, 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 lifelong insurance or care about cash value accumulation, term life provides 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 a substantial amount becomes accessible.
• Cash value is usually not paid to beneficiaries. When you die, cash value generally returns to the insurer. Beneficiaries receive the policy death benefit minus cash value loans and withdrawals you made.
• Your policy could lapse if you borrow too much. If you take policy loans or withdrawals, maintain a minimum cash value level or the policy could lapse.
• Taxes may apply. If you withdraw cash value or surrender and terminate the policy, you may owe tax on the portion attributable to interest or investment earnings.

Ways to use a cash value life insurance policy

There are several ways to access the cash value component of life insurance while alive.

• Take a loan. You can borrow against permanent life insurance cash value and use the money for anything: an emergency, supplemental retirement income, or another purpose. The loan accrues interest until fully repaid. State law may set the maximum policy loan interest rate. In California, for example, insurers cannot charge more than 8% annually.
• Withdraw cash value. When a withdrawal includes investment gains, often called the amount above basis, that portion is taxed as income. Withdrawals reduce beneficiaries' future life insurance payout.
• Surrender the policy for cash. Canceling life insurance is known as surrendering the policy. You receive cash value minus surrender charges. The insurer also subtracts unpaid premiums or outstanding loan balances.