How Life Insurance Cash Value Works and How to Use It

Short answer

Cash value is a savings component inside permanent life insurance, such as whole, universal or indexed universal life, funded by part of each premium and growing tax-deferred. You can borrow against it, withdraw from it or surrender the policy for it, but loans accrue interest, withdrawals can reduce the death benefit and surrender ends coverage. Term life has no cash value.

Key takeaways

Permanent policies, such as whole life and universal life, build cash value, and term generally does not.
Cash value grows tax-deferred, though it often builds slowly in the early years.
Your surrender value is the cash value minus any surrender charges and unpaid loans.
Policy loans accrue interest, and unpaid loans reduce what your beneficiaries receive.
Surrendering a policy ends your coverage and may create taxable income.

What cash value is and which policies have it

Cash value is a savings-like account inside a permanent life insurance policy. Whole life, universal life, indexed universal life and variable universal life can all build it. Term life generally does not. When you pay a premium on a permanent policy, part of it covers the cost of insurance and fees, and the rest can add to your cash value.

How cash value grows

Growth depends on the type of policy. In general, the growth is tax-deferred, so you do not pay income tax on it each year while it stays inside the policy. Early growth is often slow because the insurer recovers sales and setup costs in the first years. Here is how the main types work.

Whole life: grows on a guaranteed schedule, and participating policies may also pay dividends, which are not guaranteed.
Universal life: earns an interest rate that can change, with a minimum rate set in the policy.
Indexed universal life: earns interest linked to a stock market index, within caps and a floor.
Variable universal life: invests in subaccounts, so the cash value can rise or fall with the markets.

Cash value, surrender value and death benefit

These three numbers appear on your annual statement, and they are easy to mix up. Cash value is the total that has built up in the policy. Surrender value is what you would actually receive if you canceled, after any surrender charges and loan balances come out. Many policies, especially universal life, have surrender charges in the early years.

The death benefit is what your beneficiaries receive when the insured dies. On most whole life policies, that payout includes the cash value. Some universal life policies offer an option that pays the cash value in addition to the face amount, usually at a higher cost.

Ways to use your cash value

While the policy is in force, the owner can usually tap the cash value in the ways listed below. Each choice affects your coverage differently, so compare them before you act. An independent licensed agent can review your statement and walk through the numbers with you at no cost.

Policy loan: borrow against the cash value. Interest accrues, and any unpaid balance reduces the death benefit.
Withdrawal: many policies let you take out part of the cash value, which usually lowers the death benefit.
Premium payments: use cash value or dividends to cover some or all of your premiums.
Reduced paid-up insurance: stop paying premiums and keep a smaller policy that needs no more payments.
Surrender: cancel the policy and take the surrender value, which ends your coverage.

Taxes and risks to weigh first

You generally owe no income tax on a policy loan while the policy stays in force. Withdrawals are usually tax-free up to the total premiums you have paid. If you surrender the policy, you generally owe income tax on any amount above the premiums you paid. Different rules apply if a policy becomes a modified endowment contract, which can happen if you pay in too much money too quickly.

One major risk is a lapse. If a loan and its interest grow larger than the cash value, the policy can end. A lapse with a loan outstanding can also create a tax bill on money you already spent. Before you borrow or withdraw, ask your insurer for an in-force illustration and talk with a tax professional.

Frequently asked questions

Can I cash out my life insurance policy?

If you own a permanent policy with cash value, you can usually surrender it for the surrender value. That ends your coverage, and any gain over the premiums you paid is generally taxable. Before you cash out, compare other choices, such as a loan, a partial withdrawal or reduced paid-up coverage, which can keep some protection in place.

Do beneficiaries get the cash value when the insured dies?

Usually they receive the death benefit only. On most whole life policies, the cash value is part of that payout. Some universal life policies offer an increasing death benefit option that pays both, usually at a higher cost. The insurer subtracts any unpaid loans and interest from the amount your beneficiaries receive.

How long does it take to build cash value?

It varies by policy type, premium size and the insurer's costs. In the first several years, much of each premium goes to the cost of insurance, fees and sales costs, so cash value often grows slowly. Growth tends to pick up over time. Your annual statement or an in-force illustration shows how your policy is tracking.

Does term life insurance have cash value?

Generally, no. Term life pays a death benefit if the insured dies during the term and does not build cash value. Some term policies offer a return of premium feature that refunds premiums if you outlive the term, at a higher price. You can also convert many term policies to permanent coverage that builds cash value.

Is it a good idea to borrow from my life insurance?

It can be. A policy loan usually requires no credit check, and repayment terms are often flexible. Interest still accrues, though, and an unpaid loan reduces the death benefit. If the balance grows too large, the policy can lapse. A loan tends to work best when you have a clear plan to repay it or keep the balance in check.

Related guides

Have a policy with a specific company? Find your carrier for help with that policy.