The cash value of a life insurance policy refers to the amount of money the policyholder would receive if they canceled their policy before it matures or they pass away. Cash value is a component of permanent life insurance policies, including whole life, universal life, and variable life policies. It is not a feature of term life insurance. Cash value provides a saving and investment element in addition to the death benefit protection of the policy.
How Cash Value Works
With permanent life insurance policies, a portion of the premium payments go toward the death benefit coverage, while the remaining portion builds up a cash value within the policy. The cash value grows on a tax-deferred basis, meaning no taxes are due on any growth until funds are withdrawn. Policyholders can access this cash value through policy loans or withdrawals if they need access to the funds while still keeping the policy intact.
The main factors that determine a policy’s cash value include:
- The type of permanent life insurance policy
- The size of the death benefit
- The length of time the policy has been in force
- The amount of premiums paid
- The insurance company’s dividend payments, if applicable
- The rate of return earned by the cash value portion of premiums
In the early years of a policy, cash value tends to be lower because a larger portion of the premium goes toward covering administrative costs and the pure insurance element of the death benefit. As the policy ages, cash value builds up at a faster rate. Policyholders can usually borrow against or withdraw the cash value, although this reduces the death benefit.
Cash Value in a $10,000 Life Insurance Policy
The amount of cash value accumulated in a $10,000 permanent life insurance policy depends on the type of policy, the length of time in force, premium payments, dividend options, and interest rates. Here are some examples of cash value accumulation:
- A $10,000 whole life policy for a 30-year-old may build up around $3,500 in cash value over 10 years if premiums of $200 per month are paid during that time.
- A $10,000 universal life policy for a 40-year-old may accrue approximately $2,000 in cash value over 5 years given annual premiums of $500.
- A $10,000 variable universal life policy for a 50-year-old could build up $7,500 in cash value over 15 years assuming annual premiums of $1,000 and average returns of 6% in the separate account investment options.
These are hypothetical examples to illustrate how the cash value component may accumulate over time. The actual cash value build-up will vary for each policy based on specific circumstances.
Factors That Affect Cash Value Growth
Several important factors impact the growth rate and amount of cash value built up in a permanent life insurance policy:
- Type of Policy – Whole life policies tend to have higher guaranteed cash value growth than universal or variable life. Variable policies offer the potential for higher returns by investing the cash value, but these returns are not guaranteed.
- Premium Payments – Paying higher premiums results in faster cash value growth compared to paying the minimum required premium.
- Dividends – With participating whole life policies, dividends from the insurance company can be used to increase cash value.
- Interest Rates – Cash value growth depends partly on current interest rates earned in the insurance company’s general account or separate account for investment of policy funds.
- Policy Loans/Withdrawals – Any policy loans or withdrawals reduce cash value by the amount accessed.
- Age of Insured – Cash value tends to accumulate faster in the later years of a policy due to the reduced cost of insurance charges.
Cash Value vs. Death Benefit
The primary purpose of life insurance is to provide a death benefit to beneficiaries when the insured passes away. Permanent policies also include a cash value component that builds up over time. These two key features interact and offset each other to some degree:
- Accessing cash value through withdrawals or loans reduces the death benefit by that amount.
- Putting more premium dollars toward cash value means less is available to fund the pure insurance costs, which reduces the death benefit.
- Canceling a permanent policy and taking the full cash value amount terminates the death benefit entirely.
Policyholders essentially exchange pure insurance for investment cash value over the life of the policy. Finding the right balance depends on each person’s financial goals, time horizon, and risk tolerance.
Cash Value Guarantees
A key advantage of permanent life insurance policies is they come with guaranteed cash values, as long as the policyholder makes the required premium payments. With whole life insurance, the cash value growth is locked in each year. Universal life and variable life policies may offer minimum guaranteed rates, although the actual returns could potentially be higher.
These guaranteed cash values provide safety compared to investing directly in the market. Life insurance also enjoys certain tax advantages that allow the cash value to grow tax-deferred.
Accessing Cash Value
There are a few options for policyholders to access their cash value if needed before the death benefit is paid out:
Policy Loans
The most common way is to take out a loan against the policy. This allows accessing cash value without triggering taxes or surrender charges. The loan principal can be repaid at any time. If it is not paid back, the outstanding loan balance is simply deducted from the death benefit when the insured passes away.
Partial Withdrawals
Another option is to make a partial withdrawal of the cash value, subject to certain limits and conditions set by the insurer. Withdrawals are tax-free up to the total amount of premiums paid into the policy. Any amount above that is considered taxable income.
Full Surrender
Policyholders can opt to cancel their permanent life insurance policy and receive the full current cash value. Surrendering the policy terminates the death benefit, so this option essentially exchanges life insurance for cash savings. Surrender fees often apply if the policy is terminated within the first 10-15 years.
Uses of Cash Value
The investment component of permanent life insurance provides financial flexibility. Some potential uses of cash value include:
- Supplement retirement income
- Pay for college tuition
- Make a down payment on a home
- Cover emergency expenses
- Fund business opportunities
- Pay high insurance premiums if health deteriorates
- Cover long-term care expenses
- Leave a larger legacy to heirs if not needed
Having access to tax-advantaged cash value can be helpful for meeting financial goals or unexpected costs. It provides an additional funding source outside of traditional savings and investment accounts.
Pros and Cons of Cash Value Life Insurance
Here are some key advantages and potential drawbacks of policies with cash value:
Pros:
- Tax-deferred growth potential
- Dividends and interest credited from the insurance company
- Guaranteed rates and protection from losses
- Automatic saving element if premiums are paid consistently
- Access to policy loans if cash is needed
- Supplements retirement plan and savings
Cons:
- Lower death benefit for the premium dollar amount compared to term
- Limitations and fees may apply for accessing cash value
- Requires discipline to pay premiums consistently over time
- Interest rates on policy loans may be variable
- Potential surrender charges if policy canceled in early years
Conclusion
Cash value life insurance can provide lifelong protection paired with a saving and investment feature. For a $10,000 permanent life policy, cash values may accumulate to several thousand dollars over time, depending on the type of policy, premiums paid, rates of return, and other factors. This allows policyholders to tap into an additional pool of funds that can supplement their financial strategy and be used for a variety of purposes over their lifetime.