Cash value life insurance explained
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All life insurance has the same primary purpose: to provide a death benefit to your beneficiaries if you pass away. It's paid free of income tax and can be a significant source of financial protection for your family.
Some policies also have a cash value component1: A portion of your premium goes towards the death benefit, and another part goes to a cash account, where it grows tax-deferred over time. This cash value can become a significant financial asset that can be accessed throughout your life.2 Here you'll learn about:
How cash value life insurance works
What types of life insurance have cash value components
The benefits and potential disadvantages of cash value policies
What is cash value life insurance?
Some permanent life insurance policies — whole and universal3 — have a cash value component that accumulates over time as you continue to pay your premiums.
A cash value life insurance policy has two key components
The death benefit | Cash value |
|---|---|
The funds your beneficiaries will receive upon your death, paid out income tax-free. | Funds that grow over time and are available for you to use in different ways – for example, borrowed against, withdrawn, or used to pay premiums. |
The death benefit is payable in full from the first day the policy takes effect, and is guaranteed to be paid to beneficiaries — no matter what age the insured dies — as long as the policy remains in force. And with each premium payment, the cash value grows steadily over the years. So a cash value life insurance policy can help protect and build wealth at the same time: the death benefit protects family finances in the case of early death, while cash value builds family wealth, providing access to funds with tax benefits.4
How does cash value life insurance work?
When you pay life insurance premiums, a portion of your payment goes toward covering the cost of insurance (i.e., the death benefit) plus any administrative fees and other policy expenses.
Cash value growth
The remaining portion of the premium can help grow your cash value. These funds increase over time, based on how much you pay in, and how funds in the cash grow. Whole and universal life policies typically grow at a fixed interest rate, which may adjust periodically. Variable and indexed policies also allow you to assign some of your cash value to investments like equities (stocks) or index funds, which could potentially increase value growth if you are willing to accept a level of downside risk.
Guardian permanent and whole life insurance policies offer a variety of cash value growth options. You can, for example, assign some of your cash value to a fixed-rate interest account and put the rest in a market-indexed option with the potential to build cash value more quickly. Whichever method or methods you use, the cash value can be used to pay premiums, be borrowed against, or be surrendered for cash to help fund your retirement.
Accessing cash value
Once the cash account has accumulated enough funds, you can use it in a variety of ways. You can borrow against it by using funds in your cash account as collateral for a loan with favorable interest and repayment terms.5 You can typically use cash value to pay your premiums, helping to keep the policy in force after you stop working. Or you can make a policy withdrawal if needed.
Tax advantages
Cash value life insurance is tax-efficient, which means it helps your money grow faster because interest and investment earnings on the cash value aren't taxed. You can also borrow against the cash value tax-free as long as you aren't surrendering or canceling the policy.6
Estate planning
Some policyholders use life insurance with cash value components to transfer generational wealth, making it a useful estate planning tool. Tax-deferred growth can help you build cash value, and death benefits aren't subject to income tax. However, interest that your beneficiaries receive from the cash value can be taxed.7
Using cash value can affect your coverage
There are implications to using your cash value, which can affect the death benefit. If you withdraw from or borrow against your cash value, for example, the policy's death benefit will likely be reduced. Depending on the value of your cash account and your policy's terms, the impact on the death benefit could be greater than the amount you withdrew.8
it's also important to understand how your cash value is impacted if you surrender the policy. In some situations, you could owe taxes if you receive more in cash surrender value than the sum of premiums you've paid.9
Here's an example: Let's look at a policy with a $50,000 death benefit, no outstanding withdrawals or loans, and the policyholder has accumulated cash value of around $10,000.
If the policyholder passes away, the company pays the full death benefit of $50,000 to the beneficiaries named on the policy. The cash value does not get paid to the beneficiary and becomes the property of the insurer.
On the other hand, what if the policyholder had borrowed $10,000 against their accumulated cash value, without paying it back before they died? In that case, the outstanding loan amount and any associated fees and interest would be subtracted from the death benefit. So, their beneficiaries might only receive around $38,000 of the original $50,000 death benefit.
What kind of life insurance is right for you?
What types of life insurance have cash value?
Whole Life | Universal Life | Indexed Universal | Variable Life | |
|---|---|---|---|---|
Premiums | Fixed | Flexible | Flexible | Either |
How Cash Value Builds | Predictable interest Potential dividends | Interest, which may adjust to reflect current rates | Tied to index funds, Minimum | Market investment |
Market Growth | No | No | Some market upside | Yes |
Investment Risk | Lowest | Low | Some risk | Highest |
Whole life insurance
This is the most common type of cash value policy and offers the most guarantees: a guaranteed death benefit, fixed premium payments that are guaranteed to never go up, and cash value that grows tax-deferred at a predictable interest rate.11
If you get a whole life insurance policy from a mutual insurer, like Guardian, it may also earn dividends based on company performance because these insurance companies are actually owned by their policyholders. Whole life insurance with cash value can be the cornerstone of a reliable wealth-building strategy, especially if you've already leveraged other retirement or investment options that offer tax benefits.
Universal life insurance
This type of permanent life insurance policy offers greater flexibility, with premium payments that can adjust up or down within a certain range, along with the death benefit amount.
This can let you adjust your life insurance coverage and costs as your needs and income change. The cash value portion grows tax-deferred based on interest rates declared by the life insurance company.12
Indexed universal life insurance
This allows policyholders to build cash value based on the performance of an underlying index, such as the S&P 500.13 Policyholders are protected against market downturns with a minimum guaranteed interest rate. Still, annual gains are also capped, so this type of policy offers less risk and growth potential compared to a variable policy.14
Variable life insurance
This lets policyholders invest the cash value portion in a variety of market investment options. Cash value growth depends on the performance of those investments, offering more risk — and potential reward — compared to other types of cash value life insurance.15 A variable universal life insurance policy also offers flexible premiums that can be adjusted within a certain range, but care must be taken to ensure that the cash account doesn't fall below certain minimums, or the policy could lapse.
Note: Term life insurance — which lasts for a limited period of time (typically from 10-30years) — offers a death benefit but does not build any cash value.
Four ways to access cash value
A cash value life insurance policy gives you several ways to access your accumulated cash value. Before doing so, you should talk to your financial professional and a tax to determine the best choice for you. Policies terms vary somewhat, but options typically include:
Withdrawals: Policyholders can make partial withdrawals from the cash value, which are generally income tax-free up to the amount of the premiums paid. Any additional withdrawals may be subject to taxes or penalties, depending on the policy and the amount withdrawn.16 Any cash value withdrawn that exceeds the sum of paid premiums will be considered taxable income.
Loans: Policyholders can take out a loan against the cash value, using the policy as collateral. Loans can provide access to funds without triggering immediate taxes or surrender charges. However, outstanding loan balances will typically reduce your death benefit if not repaid.17 However, this is not considered taxable income.18
Surrender: Surrendering the policy involves canceling the coverage and receiving the cash value accumulated in the policy. This option may trigger surrender charges by the insurance company, particularly if you cancel in the early years of the policy.19 Also, note that any amount that exceeds your paid premiums may be considered taxable income.
Paying Premiums: You may be able to use cash value to pay premiums. This can be useful if you want to reduce regular expenses but still wish to maintain full coverage. This use isn't considered taxable income.
What are some of the pros and cons of cash value life
insurance?
If you're trying to decide if it's a good fit for you, here are some things to consider:
Advantages
Gain lifelong coverage: Cash value components are only available with universal or whole life insurance, which provides lifelong coverage with a guaranteed death benefit.
Build savings: Many policyholders use cash life insurance as a wealth building tool since they can borrow against or withdraw cash value as it accumulates.
Get tax benefits: Cash value grows tax-deferred, and loans borrowed against the cash value are income tax-free unless you cancel or surrender the policy.20
Supplement retirement income: These policies can help supplement retirement income, especially if you have maxed out other tax-advantaged retirement accounts such as IRAs.
Flexible access to funds: Unlike less liquid forms of savings, you can access cash value as soon as it’s accumulated. This can provide quick access to money without significant tax implications, and can be particularly help before you’re ready to withdraw from conventional retirement accounts.
Simplify wealth transfer: Cash value policies provide lifelong protection which can also be help with estate planning, because death benefit payouts bypass the probate process.
Drawbacks
Cost: Cash value policies usually have higher premiums than term life insurance policies with comparable death benefits.
Complexity: Cash value policies are usually more complicated than term life insurance policies, so you'll probably need to spend more time understanding and managing your coverage.
Potential for reduced death benefit: Withdrawals and loans from your cash value account can change your policy’s death benefit. This may happen if you take out a policy loan that isn’t repaid before death, or if you withdraw funds from your cash value account.21
Why so many people choose Guardian cash value life insurance
When you're looking for a permanent cash value life insurance policy, history matters. Guardian has been insuring families and individuals for over 160 years, so our policyholders can trust we'll be there when it matters. In fact, as a mutual insurance company, we're actually owned by our policyholders, so we don't have to answer to outside shareholders like some other companies.22 And financial professionals know that with some of the highest financial ratings in the industry, they can confidently recommend Guardian life insurance to their clients.
Is cash value life insurance right for you? Talk to a professional.
Permanent life insurance that builds cash value can be a powerful financial tool to help protect your family and lifestyle. Generally, it can be a good fit for those who would like a tax-efficient growth vehicle in addition to the lasting financial protection of a permanent death benefit.
That said, every individual's situation is unique. So it's a good idea to consult with a financial professional who can help you decide what's best for you. If you don't know such a person, ask friends or colleagues for a recommendation. Or, Guardian can connect you to a Financial Professional who can help.