Cash value life insurance is a form of permanent life insurance—lasting for the lifetime of the holder—that features a cash value savings component. The policyholder can use the cash value for many purposes, such as a source of loans or to pay policy premiums.
Imagine needing a loan but not having to go to a bank or lender and dealing with a credit check for them to determine IF they will approve you for the loan. Your cash value in your life insurance policy in essence becomes your own "bank". There’s no limit to how you can use cash value.
The following types of permanent life insurance policies may include a cash value feature:
Traditionally, cash value life insurance has higher premiums than term life insurance because of the cash value element. Most cash value life insurance policies require a fixed-level premium payment, of which a portion is allocated to the cost of insurance and the remaining deposited into a cash value account.
The cash value of life insurance earns a modest rate of interest, with taxes deferred on the accumulated earnings. Thus, the cash value of life insurance will increase over time. As the life insurance cash value increases, the insurance company’s risk decreases, because the accumulated cash value offsets part of the insurer’s liability.
There can be several tax advantages to purchasing life insurance and, specifically, a cash value life insurance policy. A primary tax perk is that your receive the death benefit tax-free, as with any type of life insurance. Since life insurance payout amounts can be pretty large, this is an important advantage.
Another tax advantage is that the total cash value accumulates on a tax-deferred basis. So as your cash value grows, the IRS doesn’t take a cut.
Also, if you borrow money against the policy, you won’t have to pay taxes on the loan, just as you wouldn’t pay taxes on a personal loan. The loan isn’t taxable as long as the policy is in-force.
If you withdraw cash value or take the surrender value and terminate the policy, you can be taxed on the portion of the money that came from interest or investment gains.
Therefore, it’s important to understand tax rules before taking out money so you don’t get hit with a surprise tax bill.
Your decision to buy a cash-value life insurance policy will depend on how much risk you want to assume and how much flexibility you want to have. A whole life policy is the most straightforward permanent policy because everything is fixed and guaranteed — the annual price you pay, the death benefit and the return on cash value.
Cash-value life insurance is more complicated than term life. You’ll need a trusted life insurance agent to walk you through the options.