The cash value component of life insurance is one that frequently confuses people. This is a feature that is frequently included in permanent life insurance policies. Cash-value life insurance is a type of permanent life insurance that includes a cash value savings component and lasts for the holder’s entire life. The cash value can be used by the policyholder for a variety of purposes, such as a source of loans or cash, or to pay policy premiums.
What Is the Meaning of Cash Value in Life Insurance?
A life insurance cash value feature typically earns interest or other investment gains and grows tax-deferred. Because of the cash value component, cash value life insurance has traditionally had higher premiums than term life insurance. Most cash-value life insurance policies require a fixed-level premium payment, of which a portion is allocated to insurance costs, and the remainder is deposited into a cash-value account.
If you want a cash value life insurance policy, you have several options. Each policy type accumulates cash value differently, but you can access your cash value with a loan, withdrawal, or surrender in all cases.
A cash value feature may be included in the following types of permanent life insurance policies:
- Whole life insurance
- Universal Life Insurance
- Variable Universal Life Insurance
- Indexed Universal Life Insurance
The cash value feature is not available with term life insurance.
How Can I Get Cash Value from My Life Insurance?
You can withdraw money from the cash value or take out a loan against it and use it for whatever you want: an emergency, to supplement retirement income, to pay premiums, or anything else.
Depending on the type of life insurance policy you have, you may be able to access its cash value in one of four ways:
- Withdraw your funds.
- Obtain a loan
- Surrender the policy.
- Use the cash value to assist in the payment of premiums.
Here’s more information on each option.
Withdraw your Cash Value funds
You may be able to withdraw tax-free from your permanent life insurance policy. However, if your withdrawal exceeds the amount you’ve paid into your policy’s cash-value portion, it will be taxed as income. Also, remember that withdrawing your cash value funds reduces the death benefit paid to your beneficiaries when you die.
Obtain a loan
Typically, you can borrow up to the cash value of your policy. This may include the portion of your paid premiums designated for the cash value account, as well as any accrued interest on those funds.
The interest rate on a policy loan can be fixed or variable, determined by the insurer based on current market rates. The maximum policy loan interest rate is frequently governed by state law. The loan is not taxable income, according to the American Institute of CPAs.
If you do not repay the loan amount and die, the outstanding loan balance (including interest) will be deducted from your beneficiaries’ life insurance payout. Some policyholders choose to use their cash value in this manner, expecting their beneficiaries to receive a lower payout.
Another advantage of a policy loan is that it does not show up on your credit report.
Surrendering the policy
When you surrender an insurance policy, you are canceling the coverage. When you surrender a policy, you will receive the cash value less any surrender charges. The insurance company will also deduct any outstanding loan balances or unpaid premiums. Still, if you no longer want the policy, getting some money back is preferable to walking away empty-handed.
According to Investopedia, you may also be charged additional “surrender fees,” which could further reduce the surrender value of your policy. Also, the money you receive from surrendering the policy may be subject to income tax.
Using the cash value to assist in the payment of premiums
Depending on the policy, you may be able to use your cash value to cover premium payments if you save enough money in your cash-value account. If you’re having trouble making the payments, this option may provide some relief, allowing you to keep the life insurance in force.
If you use up all of the cash value in the account, the policy may lapse, so keep track of your cash value.
Find out what the rules are for using cash value to pay your premiums from your insurance agent.
