What does cash value mean in a whole life insurance policy?

Life insurance is an easy concept: if you pass away and are no longer here to provide, then your loved ones (or chosen charities) will receive a sum of money called a death benefit, generally income-tax free. That tax-free money is meant to protect them from potential financial constraints, especially if you’re the main breadwinner, and it can be used for whatever — anything from paying off the mortgage to college funds to daily expenses. 

The next thing to know is that there are two main categories of life insurance: term life, and permanent life insurance — of which the most common form is whole life insurance. Term life insurance buys protection for a specified period of time (term) — from 10-30 years, your choice at the time you purchase it. The second major type of life insurance is permanent life insurance, and it takes financial protection a lot further. A whole life insurance policy, the most common form of permanent life insurance, guarantees that your coverage will never end as long as your premiums (your monthly payments to the insurance company) stay current.¹ Beyond the guaranteed life insurance protection, whole life has an important feature — a savings component. With whole life, you accumulate  cash value tax deferred^{2, 3}. The cash value accumulates over time and can become a significant financial asset that can be used during your lifetime in a number of ways. 

The cash value in your life insurance policy can be withdrawn or borrowed against, and there are several different approaches when deciding which way to use the money.⁴ You may be able to get a bank loan by using your policy’s cash value as collateral or borrow against the policy’s cash value to put a down payment on a house. Or you may want to withdraw money from the policy to help pay education costs. This would ultimately affect the amount of money you would be leaving to your heirs or beneficiaries (these could also be a charity or other non-profit, for instance). Talk to your financial professional, as well as a tax advisor, to determine which choice would be best for you.

Whole life insurance is tax-efficient — which means it helps your money grow faster because the interest earnings within the account aren’t taxed. If you buy your policy from a mutual insurance company, you may also receive annual dividend payments based on the financial performance of that company each year.³ These dividend payments aren’t guaranteed, so check on the track record and the current financial ratings of the insurance company before you purchase. Some companies pay dividends year after year, and they can add up in your account. Whole life insurance also has a guaranteed level premium, meaning that the monthly payments you make won’t increase over time. So while whole life insurance costs more in the early years, in the long run, the payments may seem like a remarkable deal for life insurance that can’t be canceled by the insurance company, regardless of how old you get or whatever occurs to affect your health. 

There are several approaches when deciding on withdrawing versus borrowing.⁴ You may be able to get a bank loan or a mortgage by borrowing against the cash value account as  guaranteed collateral. Or you may borrow or withdraw the money from your own policy, depending on whether or not you wish to pay the money back. This would ultimately affect the amount of money you leave to your heirs or beneficiaries (which could be family members or a non-profit). Talk to your financial professional, as well as a tax advisor, to determine which choice would be best for you. 

Make sure to buy from a reputable life insurance company. Check out how long they’ve been in business and their financial ratings.⁵ Several independent companies, like Moody’s Investors Service, Fitch, and Standard & Poor’s rate companies in terms of assets, how they’re run, and whether they’re at risk, and these ratings can be found easily online.⁶ For many reasons, you want the insurance company you choose to have high ratings, not just for your life insurance coverage, but also to make sure your cash value keeps growing securely. Remember, once the cash value in your account has built up, you could use it to do a number of things during your own lifetime. You can pay your policy’s premiums.⁷ You could grow the amount of money awaiting your beneficiaries. A whole life policy can give you options to fit your lifestyle and the kind of life you see ahead of you.