For many people, a permanent life insurance policy forms the cornerstone of their financial plan. It’s easy to see why: There’s the guaranteed death benefit for life, as well as benefits you can enjoy while you’re living.
Cash value is one of those key living benefits, and it can be an important part of your financial plan. At the same time, cash value is one of the more commonly misunderstood features of permanent life insurance.
WHAT IS THE CASH VALUE OF PERMANENT LIFE INSURANCE?
Cash value is a component of a whole, universal or variable life insurance policy. It’s essentially a source of liquid funding held within your life insurance policy, and you can choose to access it any time. It is separate from the death benefit, which is only paid to beneficiaries after your death.
HOW DOES CASH VALUE WORK?
Here’s what typically happens when you pay your permanent life insurance premiums: Some of your premium covers costs of insuring you, a portion funds your provider’s overhead and another portion goes toward the policy’s cash value, which grows based on company performance (the rate of return will vary by company and policy type). In many cases, your cash value never declines, which can make it a very stable part of your overall financial plan. To be clear, it takes several years of paying premiums for cash value to grow to an amount you’d want to use.
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Once you have accrued cash value in your policy, you can use it – though it will affect your policy (below). Therefore, in addition to offering financial protection to your family after your death, cash value can serve as a layer of protection while you’re alive.
WHAT CAN YOU USE CASH VALUE FOR?
You can access the cash value for anything you wish — it’s your money. Some common ways that policyholders use cash value include:
- Paying premiums
- Paying a child’s college tuition
- Paying for an emergency expense
- Funding a down payment or collateral on a mortgage or personal loan
- Covering living expenses in retirement during down markets so you don’t have to sell holdings at low prices
DOES CASH VALUE NEED TO BE REPAID?
If you were to fully surrender (or close) your permanent insurance policy while you were still alive, you would lose the policy’s death benefit. However, you would receive any accrued cash value, which you could then use for whatever purpose you wish. It’s important to bear in mind that you may owe income tax if the cash value exceeds the total amount of premiums you have paid into the policy.
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If you wish to access your cash value while maintaining your policy, you have two options.
Partial cash surrender. Sometimes called a withdrawal, a partial cash surrender is tax free up to the amount of cumulative premiums you have paid. When you make a partial surrender, your death benefit will be reduced.
Take out a loan. In this case, you could take out a life insurance loan against the cash value you’ve accumulated.
You can make payments on the loan as you see fit, however the outstanding balance will accrue interest over time. You’ll need to keep close tabs on those interest charges as the balance of the loan will grow. If the loan total, plus interest, exceeds your policy’s cash value, your policy could lapse. If that happens, you may owe taxes on a portion of your borrowed money. Further, if you die before the loan is paid off, the remaining balance will be subtracted from the death benefit.
If you’re considering this option, it might be a good idea to reach out to a financial professional to help dig into the pros and cons of a life insurance loan.
CASH VALUE IS A USEFUL FINANCIAL TOOL
Cash value accumulation is an important benefit that distinguishes permanent life insurance from term. No doubt, term life insurance policy is an inexpensive way to purchase a larger amount of temporary coverage, but a permanent life insurance policy with a cash value component offers protection and living benefits that can add another layer of flexibility to a comprehensive financial plan.