While its primary advantage, the death benefit, helps protect your loved ones if something happens to you, cash value life insurance policies can be used as a financial resource to support your long-term financial goals while you're alive.
Like most permanent life insurance policies, such as whole life and indexed universal life (IUL), the cash value component offers diverse uses throughout your life. In your thirties, for example, family protection could be its main purpose. In your 50s, you may borrow some of the cash for your child's college tuition. During your 60s, it could be a source of tax-advantaged retirement income.
Understanding cash value in life insurance
Life insurance with cash value is like having two accounts in one: part of your premium buys coverage, and the rest grows in a cash value account at a rate set by the insurer. This cash value is money you can access while you're still alive. Depending on your policy, you may be able to withdraw or borrow against it. There is, however, a trade-off when using the cash value, as it usually reduces the death benefit your beneficiaries would receive.
The cash value in IUL policies works differently. Part of your cash value can grow through interest that's credited in two ways: either with a fixed rate or based on an index strategy. You choose how to split your money between these options, giving you flexibility and control.
With an IUL, the cash value of the policy has the potential to earn interest based on the performance of a market index (like the S&P 500). It's important to note that your money isn't actually invested in the market. The index is simply used as a benchmark to calculate the percentage of the index gains you will receive, based on the crediting strategy you select in your policy.
United of Omaha's Income Advantage policy, for example, offers downside protection, so even during market downturns, you won't lose accumulated cash value.
Six scenarios where life insurance cash value can help
Insurance companies like United of Omaha build their policies to grow cash value over time, offering valuable financial flexibility. You can access cash value through policy loans or withdrawals to help you manage unexpected expenses or manage retirement cash flow. Here are a few ways to use your life insurance's cash value.
- Extra retirement money: Offers another way to get money during retirement, with more control than a 401(k).
- Education costs: Tap the cash value to help fund college costs without loans or credit checks.
- Medical emergencies: Pay for unexpected medical bills with the cash value.
- Long-term care: Help cover the high cost of ongoing long-term care or assistance.
- Paying premiums: Use funds for policy payments during tough times.
- Backup funds: Use cash value as an extra emergency fund.
Things to keep in mind with cash value
There are a few key points to remember when deciding how to use your cash value account.
Policy loans and withdrawals reduce the death benefit if not repaid, potentially affecting the legacy you planned to leave to beneficiaries. Understanding how borrowed amounts affect your overall insurance protection is essential. If you borrow too much from your policy, you could lose your life insurance completely. This happens when what you owe (your loan plus interest) becomes more than the cash value in your policy. If this occurs, your policy will be canceled, leaving you with no life insurance protection. You might even owe taxes on the money you borrowed.
When you borrow from your policy, you're charged interest on the loan amount. This interest builds up over time, but most companies give you flexibility in how and when you pay it back. You can make interest-only payments, pay back part of the loan, or even let the interest add to your total loan amount. However, remember that the bigger your loan gets, the less death benefit your family will receive.
Your cash value: A financial asset that works for you
While life insurance's primary purpose remains protecting loved ones with a death benefit, the cash value of your policy transforms it into a versatile financial asset that supports your long-term financial goals throughout your lifetime. Consult a licensed financial representative to help you balance immediate needs with long-term policy performance and goals.
Frequently Asked Questions
Yes, surrendering your permanent life insurance policy allows you to cash it out. But you should consider these factors before making that decision:
- Surrender value: The cash surrender value is typically less than the total amount paid in premiums, especially in the early years.
- Tax implications: You'll receive the accumulated cash value minus any surrender charges, and the amount may be taxable.
The cash value typically begins accumulating after the first year, but significant growth usually occurs over 10-15 years.
The outcome depends on your policy type and accumulated cash value.
- Whole life options: Use the cash value to pay premiums, convert to a reduced paid-up policy, or take the extended term insurance option.
- Universal life: Policyholders may continue using cash value to cover monthly charges until depleted, after which the policy lapses.
- Grace period: Most permanent policies have a grace period (typically 30-31 days) where coverage continues even if premiums are missed.