If you have a permanent life insurance policy, or you’re considering one, you might be wondering about the “cash value” attached to it. Cash value sounds appealing, sure, but how valuable is it? Can you tap into that money whenever you want? Or are there strings attached? Here, we’ll answer your questions about what it means to have cash value life insurance and how those funds can actually be put to work for you.
What Is ‘Cash Value’ and What Can You Do With It?
“Cash value” is the savings component of a permanent life insurance policy. Funds in the account come from premiums you pay to your insurer, and savings build up over time through interest or investments. People who buy permanent insurance often see this as a perk because it’s a tax-free way to grow a nest egg. But before you get too invested in the idea, it’s worth noting the limitations of cash value life insurance.
Using the money in your cash value account usually works more like a loan than a true withdrawal.
In short, the money in your cash account can’t be taken out freely. Because it’s tied to your life insurance (and comes with tax benefits), there are terms and conditions in place about accessing your policy’s savings. As a rule of thumb, it helps to think about cash value as a loan office rather than a bank vault — because if you don’t repay what’s taken out, there are generally penalties.
4 Ways You Can Actually Use Your Cash Value
Borrow from it
Once you’ve built up a sizeable cash value on your permanent life insurance, you’ll be able to take out loans from that account — which come with a few benefits.
First, loans from your cash value life insurance charge a much lower interest rate than most bank loans, so you’ll be under less pressure when it comes to paying them back. It’s also a lot easier to get a loan from your cash value than from a bank. Since you’re effectively borrowing from yourself, there’s no underwriting involved in order for you to qualify.
So, if you’re borrowing from yourself, do you have to pay the loan back? Technically, no. But if you don’t pay a policy loan back in full, any outstanding balance (plus unpaid interest) is subtracted from your policy’s overall value or “death benefit.” That means less financial support for your beneficiaries when you eventually pass away.
Take a partial withdrawal
As an alternative to taking out a loan against your cash value, you can do something called a “partial withdrawal.” In a sense, this works like a withdrawal from your bank account: You tap it, take the money out, and use it as you please.
Partial withdrawals are also tax-free — as long as the amount you take out doesn’t exceed what you’ve paid into the account through premiums. Anything beyond what you’ve paid in yourself (i.e., interest and earnings from investments) will be taxed if you decide to withdraw it.
The other catch? The amount you take out is usually subtracted from your policy’s overall death benefit. Sometimes the money you extract can’t be paid back in, either, which means that a partial withdrawal has the potential to permanently reduce the benefit provided for your family by your life insurance.
If you’re considering this route, carefully weigh the benefits of a temporary cash influx against the impact a withdrawal could have on your family’s future financial security. We recommend working with your agent or financial planner to make sure you fully understand your insurer’s rules about partial withdrawals and the effect one would have on your death benefit.
Use it to pay premiums
If your cash value grows big enough, you’ll also be able to use it to pay premiums later in life. This can be helpful if you’re paying particularly high rates; the option to cover a few months’ worth of premiums with your cash account offers some breathing room during times of financial stress while keeping your coverage intact.
Just note that if you dig too deep into your cash value account to cover premiums, the policy could still lapse. Rules vary by company, but you’re generally required to maintain a minimum amount in your cash account for the policy to stay in force.
Make sure you talk to your insurance agent and fully understand their rules about cash value before you tap into the account to cover premiums (or anything else, for that matter).
Surrender your policy and withdraw the cash
A policyholder can also decide to surrender their permanent life insurance altogether and take the cash value as a lump sum. That might sound like a nice windfall during tough times, but there are a few big caveats worth noting.
First, insurers usually charge a “surrender fee” if the insured person gives up their life insurance within the first 10 years or so. This fee will be taken out of the cash value reimbursement, thus reducing their overall payout.
Second, many companies set an initial “surrender period” for the first two or three years that a policy is in force. If the policyholder gives up their insurance during that time, they won’t receive any cash reimbursement. (Although, to be fair, cash value accounts generally don’t start building substantial value until after the first 15 or 20 years, anyway.)
And if you’ve racked up a really sizeable cash account? Even more than you paid into your policy over the years? You’ll be taxed on any savings withdrawn that exceed the total amount you’ve paid in premiums while you were insured.
Most importantly, remember that if you surrender your life insurance and take the cash, you lose the financial safety net you originally set out to secure for your family. That’s why surrendering for cash value should only be seen as a last resort.
Investing in permanent life insurance is a big decision. Premiums can easily run you hundreds of dollars per month, and you’ll only see a return on the policy if you pay those premiums faithfully for decades.
We recommend speaking with a financial professional (either an independent insurance agent or a financial planner) before making the leap to permanent life insurance. If you’re not quite ready to have that talk, start with our article on term life versus whole life insurance to learn about the pros and cons of your two main options.