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What is cash value life insurance?

Bankrate logo Bankrate 5/18/2020 Lauren Ward
a person sitting on a table: 10’000 Hours/Getty Images © 10’000 Hours/Getty Images 10’000 Hours/Getty Images

A cash value life insurance policy is basically the same as a regular life insurance policy but with one important difference: a portion of the money you pay each month gets put into a savings account that you can access in various ways as you see fit.

a man and a woman sitting on a table: What is Cash Value Life Insurance? © 10'000 Hours/Getty Images What is Cash Value Life Insurance?

Is there a catch? Why doesn't everyone choose a cash value life insurance policy? We answer these questions and a few more below.

What is cash value life insurance?

A cash value life insurance policy is a little different from other life insurance policies. It's still a life insurance policy, but it comes with a perk: a savings account that grows over time. Should you need a loan or some quick cash, you can access these funds.

It's still primarily a life insurance policy, so should you die, your family will receive cash. It just comes with the savings account bonus.

There are numerous cons with cash value life insurance, but one is bigger than all others: any amount of money you've built up over the years doesn't go to your family. Instead, it goes to the insurance company.

How does cash value life insurance work?

Each month you pay your premium. A little bit of your payment goes into a savings account. Over time it builds up to the point of being enough for you to do something with it.

For example, say you've built up a few hundred dollars in your cash-value account. Instead of paying the $30 a month premium, you could instead use that money to make your payments.

Types of cash value life insurance

There are three types of cash value life insurance policies. They are:

  • Whole
  • Variable
  • Universal

Learn the differences so you can pick the best choice for you.

Whole life insurance

With a whole life insurance cash value policy, your premium stays the same forever. Whatever amount you pay for your policy is your cast for the entire policy. However, a small percentage of what you pay goes into the cash value portion of your account with each payment.

The rate of return you receive off the savings account varies with each company, but it is usually around two percent. The longer you live and have your policy, the more time your cash will accumulate with each payment and grow with interest.

Variable life insurance

Unlike whole life insurance, variable life insurance allows you to choose how your accumulated cash is invested. Instead of having it sit in a savings account, you have a few more choices. For example, you can invest it in stocks or bonds.

There are two cons with this type, however. First, you have to know what you're doing, and variable life insurance has higher fees than whole and universal cash value life insurance.

Universal life insurance

With universal life insurance, you have some control over what you pay for your premium. For instance, if you have a good month, you could overpay what you normally would and have the surplus go into your savings account. Likewise, if one month you're a little short, you can use your savings account to pay your monthly premium.

To complicate matters even further, there are three types of universal life insurance. They are guaranteed universal life, indexed universal life and variable universal life. Which type you choose changes how your money builds up month to month.

How to use the cash value from your life insurance

There are five ways you can use your cash value.

Make a partial withdrawal

You can withdraw money straight out of your cash-value account, but there's a catch: when you do, the amount of money your beneficiaries receive when you die decreases. Even though it's money that you deposited, if you use it, your life insurance policy goes down.

Take out a loan

You can take out a loan against the cash value you've built up. However, consider this: You're going into debt over money that's yours, and you're paying interest on top of it. Should you be unable to pay it back before you die, your death benefit to your family will decrease.

Pay your premium

Use any amount of money you've accumulated to pay for your monthly premium. Depending on which life insurance company you work with, there may be a withdrawal fee to do so.

Sell your policy

Once all of your children have grown up or you don't feel as if there is a need to have life insurance anymore, you can sell your policy for a cash settlement. The agent who set you up with your insurance will receive a cut from your settlement.

Surrender your policy

Instead of selling your policy, you can instead surrender it. Any cash value you've built up over the years will be given to you after numerous fees are taken out. If the cash value is more than you've paid in premiums over the years (which is unlikely), you'll be taxed on any profits you've made.

Frequently asked questions

What happens to the life insurance cash value when you die?

When you die, your family doesn't receive any of the cash value you've accumulated over the years. Instead, all of the money is taken by the insurance company.

Can I withdraw cash value from life insurance?

Yes, you can get a portion of your cash from your cash value savings account. Should you withdraw more money than you've put in- meaning you withdraw an amount that includes any gains you've made- that money will be taxed at whatever income rate you have. Plus, your death benefit will then be reduced by whatever amount you withdraw (whether you dip into gains or not).

Do you have to pay back a cash-value withdrawal?

If you don't want your death benefits to decrease, you have to pay back any amount you withdraw. If you're fine with your death benefits decreasing, you can withdraw any amount you've put into your cash value savings account.

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