When you’re considering life insurance, it’s natural to think about the death benefit first. After all, the primary purpose of a life insurance policy is to provide security for your family after your death and it’s the death benefit that ultimately makes this possible. 

But that doesn’t mean that the death benefit is the only benefit that life insurance provides—or that it’s the only factor you should consider. Certain types of life insurance policies also build cash value (sometimes called cash surrender value), which has unique qualities that can make it an important part of your financial plan. 

What is the cash value of life insurance? 

All life insurance policies include a death benefit, which is the sum of money paid out to your beneficiaries upon your death. Many people get temporary policies that will pay a death benefit only if you die in a specified time frame, usually 10, 20 or 30 years. These policies—known as term life insurance—only offer a death benefit. 

But permanent life insurance pays a death benefit no matter when you die. This category of life insurance is also sometimes referred to as cash value life insurance because it’s the type of insurance that accumulates cash value. 

The difference between the two types of insurance is similar to the difference between renting or buying a home. The benefit of either is that you get a place to live. But when you rent, as soon as you stop paying, you no longer have the benefit of the place to live. When you buy, over time, you build equity in your home and eventually you will own it. Permanent life insurance is similar.   

The equity you earn in your home is similar to the cash value you accumulate with a permanent life insurance policy. Cash value is a unique feature of a permanent life insurance policy that allows you to build up cash and borrow from your policy.  

What kind of life insurance policies have cash value? 

While permanent life insurance is the category of insurance that typically builds cash value, there are several different types of permanent insurance that work in different ways. They are: 

• Whole life insurance 

• Universal life insurance 

• Variable universal life insurance 

How does cash value of your life insurance policy accumulate?  

With permanent life insurance, your family is immediately protected by the full death benefit. A permanent life insurance policy is also designed to build cash value over time. Cash value accumulates with your premium payments as well as other methods that depend on the type of policy you have.  

With whole life insurance, cash value is guaranteed to grow in a tax deferred way and is unaffected by market volatility. Other policies — like universal life insurance — offer more flexibility over how cash value accumulates. Variable universal life offers the ability to get exposure to financial markets, but it also comes with investment risk. Depending on the performance of the underlying investment options, the cash value could decline. 

If your life insurance policy pays dividends, you can choose to use them to buy additional insurance—known as paid-up additions—which can increase your policy’s death benefit and cash value more quickly than what’s guaranteed. 

What can you use cash value for? 

Once you accumulate cash value, you can access it for virtually any reason that you want. There are no rules that state you can only access it in certain situations or use it for certain purposes. 

Some common reasons people access their cash value include: 

• Covering an emergency 

• Funding a down payment on a mortgage 

• Remodeling a home 

• Paying for a wedding 

• Helping your child pay for college 

• Taking advantage of a business opportunity 

However, most frequently cash value can be used to supplement your income during retirement. This can be especially beneficial as it can give you flexibility during market downturns. By relying on your cash value during down markets instead of your investments, you give those investments more time to rebound in the market, which can give them the opportunity to recoup any value lost. 

What happens when you withdraw cash value from your life insurance?  

Withdrawing cash value from your life insurance policy can reduce the death benefit of your policy until you pay it back. You’ll also pay interest on the funds you took out until you pay them back. There are also ways to withdraw cash value from your policy permanently—meaning you wouldn’t have to pay a loan back—but these options ultimately impact your life insurance coverage and can result in you forfeiting your coverage entirely. This route can also result in you owing taxes on any gain in your policy above the basis that you paid in. 

How you can access the value of your life insurance policy  

Generally speaking, you can access the cash value of your life insurance policy in one of three ways: 

Take out a loan   

This option allows you to borrow money from your life insurance company, with the policy’s cash value acting as collateral. Think of this as kind of like a home equity line of credit: The insurance company extends you credit with your policy as collateral. If you take out a life insurance loan, you’ll ultimately need to pay it back — with interest. It’s important to manage any loan because if it accrues too much interest, the insurance company may surrender your policy, which can result in a negative tax consequence. If you die while there is a loan, the death benefit will be reduced by the loan amount plus any interest that has accumulated.  

Pros and cons of taking a loan from your life insurance policy  

Pros:  

• There are no restrictions to what you can spend the money on.  

• While you need to pay back the loan, you can pay it back on your own schedule (though you’ll be charged interest).  

• Your loan will not be taxed as income and the loan will not impact your credit.  

Cons: 

• If you do not repay the loan or die before repaying it, the death benefit decreases. (You could also eventually lose coverage and face a negative tax consequence if you do not manage the loan.)  

• You owe interest on the money you take out, which is additional money that’s coming out of your pocket.  

Partial surrender 

A partial surrender allows you to give up a portion of your life insurance policy (reducing its death benefit) and take that portion of your cash surrender value. Though you won’t have to pay back what you take out, you’re giving up a portion of your death benefit for good. Doing this can also have tax implications. If the cash value you take out equals more than the basis you paid in, you could be taxed on distributions above that amount.   

Pros and cons of a partial surrender of your life insurance policy 

Pros:  

• You do not need to pay back the money that you take out. 

Cons:  

• You permanently reduce the total amount of your death benefit.  

• If you take out more than the basis you’ve paid in, you’ll have to pay income tax on distributions beyond your cost basis amount.  

Total surrender 

A total surrender allows you to access all of your cash surrender value, but requires you to forfeit your entire policy, meaning you will give up the entire death benefit. This can also have tax implications, and some companies may require you to pay an additional surrender charge (Northwestern Mutual whole life insurance policies do not have a surrender charge).  Depending on your policy, this can be as high as 10 to 35 percent—but it usually goes down over time.  

Like with a partial surrender, you’ll have to pay income taxes on any funds beyond the amount you paid into your policy. And because you’re likely taking more out with a total surrender than with a partial surrender, the odds are higher that you’ll have to pay more in taxes than you would with a partial surrender.  

Pros and cons of a total surrender of your life insurance policy 

Pros: 

• You no longer have to pay premiums and you receive all of your cash value (less any surrender charges and taxes).  

Cons:  

• You terminate your policy, which means your beneficiaries will no longer receive a death benefit.  

• Depending on when you surrender your policy and how much your cash value is, you could be on the hook for hefty surrender charges and added taxes.   

Cash value offers financial flexibility  

At the end of the day, when combined with a range of other financial options, the cash value that accumulates in your permanent life insurance policy offers you significant financial flexibility during your life. A Northwestern Mutual financial advisor can help you learn about the range of permanent life insurance policies available to you and see how life insurance—and its cash value—fits into your broader financial plan.

Dividends are not guaranteed. Utilizing the cash value through policy loans, surrenders, or cash withdrawals will reduce the death benefit; and may necessitate greater outlay than anticipated and/or result in an unexpected taxable event. Assumes a non-Modified Endowment Contract (MEC). Loans taken against a life insurance policy can have adverse effects if not managed properly. Policy loans and automatic premium loans, including any accrued interest, must be repaid in cash or from policy values upon surrender, lapse or the death of the insured. Repayment of loans from policy values upon surrender or lapse can trigger a potentially significant tax liability and there may be little or no cash value remaining in the policy to pay the tax. The policy will lapse if loans become equal to the cash value while the policy is in force and additional cash payments are not made. 

The Northwestern Mutual Life Insurance Company, Milwaukee, WI. Principal Underwriter: Northwestern Mutual Investment Services, LLC (NMIS) (securities), subsidiary of NM, registered investment adviser, broker-dealer, member FINRA and SIPC. Not all Northwestern Mutual representatives are advisors. Only those representatives with “Advisor” in their title or who otherwise disclose their status as an advisor of Northwestern Mutual Wealth Management Company (NMWMC) are credentialed as NMWMC representatives to provide advisory services.