Fidelity Life: How the Cash Value of Life Insurance Works

Permanent life insurance policies offer guaranteed lifelong coverage to the policyholder in exchange for higher premiums. But the reason these premiums are pricier is that they're also going toward a growth component in the policy called the cash value. Depending on the policy, policyholders can borrow or withdraw from it, and even use it to pay premiums when it's large enough. Read on to learn more about what cash value is and how it works with different types of permanent life insurance policies.

What is cash value?

The cash value is a growth component that's part of a permanent life insurance policy. Part of each premium the policyholder pays goes into the cash value. It then begins growing tax-deferred at a specific rate, depending on the type of permanent policy.

Once a policyholder grows their cash value enough, they can take advantage of it in several ways: 

• Withdraw from it: Policyholders may be able to withdraw some of their cash value with certain types of policies. This may reduce the death benefit, and gains may be subject to taxes.
• Borrow from it: With enough cash value, policyholders can take out a low-interest, no-credit-check loan. They can pay it back at their leisure, as long as it doesn't exceed the remaining cash value.
• Pay premiums: Some policies may let policyholders cover some or all of their premiums with their cash value.
• Surrender the policy: Policyholders can get their full cash value minus surrender charges if they surrender their policy. Any gains may be subject to taxes.

Types of permanent life insurance policies with cash value

Several forms of permanent life insurance policies offer a cash value component. But each one works slightly differently. Here are some of the most common policies that come with cash value:

Final expense insurance

Final expense insurance is a type of whole life insurance policy that can help cover end-of-life expenses like funeral and burial costs. This is an affordable life insurance option for older adults who want to ensure their loved ones can get the financial protection they need in the event of the policyholder's passing. 

The premiums that the policyholder pays will go toward the death benefit and the cash value, which has a fixed interest rate. Once the policyholder has built up enough cash value, they may be able to borrow from it with no credit checks at a low interest rate or withdraw from it. If they decide they no longer need the policy, they can surrender it and receive the cash value they've accumulated.

Universal life insurance

Universal life insurance offers cash value with a fixed rate, but it also has an adjustable death benefit (keep in mind that policyholders may have to undergo another medical exam if they want to adjust it). Additionally, raising the death benefit may raise the policyholder's premiums.

These policies also come with flexible premiums. When a policyholder has enough cash value, they can use it to cover some or all of their premium payments. That said, if they run out of cash value, they will have to start paying premiums out of pocket again.

Indexed universal life insurance

Indexed universal life insurance policies share a few of the same features with universal life insurance policies — adjustable death benefits and the ability to pay premiums with cash value. But with this type of permanent life insurance, the insurer invests the cash value into a fund that tracks a stock market index, such as the S&P 500 or Nasdaq. As a result, policyholders can potentially earn more growth on their cash value.

Additionally, insurers offer minimum interest rate guarantees on indexed universal life insurance cash values. If the market performs poorly, this guarantees the policyholder still earns money.

Variable life insurance

Variable life insurance policies have adjustable death benefits and the ability to pay premiums with cash value. Like indexed universal life insurance policies, the cash value can be invested. But with this type of life insurance, the policyholder can invest the money in a wide variety of individual investments, such as stocks and bonds, for more potential growth than any other type of permanent policy.

That said, there is no minimum interest rate guarantee on variable life insurance policies. This means that policyholders can lose money if their investments decrease in value. 

The bottom line

Life insurance with cash value will typically cost more in premiums than term life insurance and offer lifelong coverage. So, this type of life insurance may be best suited for policyholders who want the peace of mind of guaranteed coverage and need an additional way to build wealth. If a policyholder believes life insurance with cash value is right for them, picking the right type of policy is a matter of risk tolerance.

Policyholders who prefer less risk and less effort might opt for a whole life policy. It has fixed interest, premiums, and death benefits. Each other policy expands the options for customizing these features and the cash value's investment. Ultimately, policyholders should closely compare the features and benefits of each policy type and individual insurers before moving forward with a permanent life insurance plan.

For all media inquiries, contact: 

Laura Zimmerman, Chief Marketing Officer

laura.zimmerman@fidelitylife.com, (312) 288-0068