What is a Cash Value Account?
In life insurance, a cash value account is an account held within a permanent life insurance policy. The policy owner has opportunities to grow and use the cash value. Those opportunities vary depending on the type of life insurance policy.
How cash value works in life insurance
When you buy permanent life insurance, your policy comes with a savings and investment component called a cash value account. Life insurance with a cash value component costs more than life insurance without it (e.g., term life insurance).
When you pay the premiums on a permanent life insurance policy, a portion of that money gets redirected to your policy’s cash value. That means your cash value will grow slowly over time.
But that’s not the only way to build cash value within your life insurance policy. Different policy types come with different growth opportunities.
The cash value is a living benefit associated with your policy. That means the policy owner can use it during their lifetime, but their beneficiaries won’t receive it when they die. Instead, any money remaining in the cash value account goes back to the insurer.
Types of cash value life insurance
The cash value accounts within different types of permanent life insurance policies function differently:
Whole life insurance. This is the simplest type of permanent life insurance. The cash value of a whole life insurance policy grows at a fixed rate.
Universal life insurance. These policies grow in alignment with market rates and the financial performance of the insurer. This cash value comes with a minimum guaranteed rate, so your cash value will grow over time even if investments or the insurer perform poorly.
Variable life insurance. With variable policies, your cash value gets invested into subaccounts of your choosing and grows in accordance with the performance of those investments.
Indexed life insurance. With these life insurance policies, the cash value is tied to a market index (e.g., the Dow Jones Industrial Average, Standard & Poor’s 500) and grows in alignment with the performance of that index.
Ways to use the cash value
Generally, you won’t be able to use your cash value in the early years of your policy. It takes time for the account to accrue a sufficient amount of money to be usable. That threshold varies based on your insurer and your policy’s terms.
Once you reach a sufficient amount of money in your cash value account, you can use it for:
- Loan collateral. Your life insurer can use the cash value to secure a low-interest rate loan for you. These loans come with flexible repayment timelines and taking one out won’t affect your credit score.
- Premium payments. If you have a variable or universal life insurance policy, you will likely have the option to use your cash value to pay your premiums. Keep an eye on the account, though, because using up all of your cash value in this way can cause your policy to lapse.
- Surrender value. If you want to give up your life insurance policy, the insurer will cut you a check for the amount in your cash value account, minus any surrender fees.
- Partial withdrawal. Some policies allow for a partial withdrawal of the cash value. Be advised that the insurer may reduce your policy’s death benefit by an amount that’s greater than the withdrawal you take. Also, if you withdraw more than you’ve paid into the policy in premiums, that overage can be taxed as income.
- Paid-up additions. Some policies allow you to use your cash value to purchase an additional death benefit.
Be advised that your cash value isn’t necessarily free money. If you take a loan against it and die before repaying that loan, for example, the life insurance provider will subtract the outstanding amount from your death benefit before paying your beneficiaries.
Ultimately, your policy’s cash value may be a useful tool, but you should be sure that you understand the parameters around using it. Specifically, get informed on how using your cash value will affect the amount of death benefit you leave to your beneficiaries.
Cash value and dividends
Even if you never touch your cash value, it can still offer you a benefit in the form of dividend payments. Most life insurance companies pay dividends to their policy owners. The amount of the dividend you receive is a percentage of your cash value, so the more you’ve accrued there, the larger the dividend you can expect.