Does Permanent Life Insurance Have a Cash Value?

Permanent life insurance policies include a savings component that accumulates value over time. This accumulating portion is known as cash value. The article will explain what cash value is, how it accumulates, how policyholders can access it, and what happens to it when a policy terminates.

Understanding Cash Value

Cash value represents a portion of premium payments made into a permanent life insurance policy. It functions as a savings or investment component separate from the death benefit. This component grows on a tax-deferred basis, with earnings not taxed until withdrawn.

A part of the premium covers the death benefit cost, another goes towards policy expenses, and the remaining portion contributes to the cash value. This allocation allows permanent life insurance to provide both a death benefit for beneficiaries and living benefits for the policyholder through the accessible cash value.

How Cash Value Accumulates

The accumulation of cash value depends on the specific type of permanent life insurance policy. For whole life insurance, cash value grows at a guaranteed interest rate set by the insurer. Policyholders may also receive dividends, which can further increase the cash value if the policy participates in the insurer’s profits.

Universal life insurance policies offer flexibility in premium payments and death benefits. Their cash value growth is tied to an interest rate, which can be fixed, indexed to a financial benchmark, or variable. Policy fees and administrative charges are regularly deducted from the cash value, affecting its overall growth.

Variable universal life insurance links cash value growth to the performance of underlying investment sub-accounts chosen by the policyholder. These sub-accounts operate similarly to mutual funds, offering potential for higher returns but also carrying investment risk. The cash value can fluctuate based on market performance, and policy charges are also subtracted from this value.

Accessing Cash Value

Policyholders can access the accumulated cash value in a permanent life insurance policy through several methods while the policy remains in force. One way is through policy loans, where the policyholder can borrow against the cash value. The cash value serves as collateral for the loan, and interest rates on these loans are set by the insurer, ranging from 5% to 8% annually.

While the policy remains active, the loan reduces the death benefit paid to beneficiaries if not repaid before the insured’s death. Policyholders are not required to repay the loan, but interest continues to accrue, increasing the outstanding loan balance. The policy continues to provide coverage as long as the cash value, after accounting for the loan, is sufficient to cover ongoing policy charges.

Another method is to make partial withdrawals from the cash value. This directly reduces the cash value and the policy’s death benefit. Withdrawals are tax-free up to the amount of premiums paid into the policy, known as the cost basis. Any withdrawals exceeding this cost basis may be subject to ordinary income tax.

Policyholders can also use the accumulated cash value to cover future premium payments. This option allows the policy to remain active without direct out-of-pocket premium payments, drawing from the cash value instead. This helps ensure the policy does not lapse.

Cash Value and Policy Termination

When a permanent life insurance policy is terminated, the treatment of its cash value depends on the specific circumstances of termination. If a policyholder chooses to surrender the policy, they voluntarily give up the death benefit. In return, they receive the cash surrender value, which is the accumulated cash value minus any applicable surrender charges and outstanding policy loans.

Surrender charges are fees imposed by the insurer, particularly in the early years of a policy, to recover initial costs of issuance. These charges typically decline over a period, often 10 to 15 years, until they reach zero. Any gain on surrender, meaning the cash surrender value received exceeds the total premiums paid into the policy, is generally subject to ordinary income tax.

If premiums are not paid and the policy’s cash value is insufficient to cover ongoing policy charges, the policy may lapse. A lapse means the policy terminates, and the death benefit is no longer in force. In most cases, any remaining cash value, after all charges are accounted for, is forfeited, though some policies may offer non-forfeiture options providing reduced paid-up insurance or extended term insurance.

Upon the death of the insured, the death benefit is paid to the designated beneficiaries. The cash value is typically absorbed by the insurer at this point and is not paid out in addition to the death benefit. However, some specific policy designs or riders may allow for the cash value to be paid in addition to the face amount of the policy, often referred to as a “death benefit plus cash value” option.