What is the Cash Value of a Life Insurance Policy?

Cash value in a life insurance policy is an accumulated benefit you can use while the policy is still in force or take with you when you cancel the policy.  Cash value accumulates through the payment of premiums.  There are various things you can do to a life insurance policy to enhance the cash value that accumulates in your policy.  The specific type of policy you have will determine exactly how cash value accumulates.

How Cash Value Accumulates in a Whole Life Insurance Policy

Cash value accumulates in a whole life policy by paying the required whole life premium.  Doing this will create guaranteed-cash value accumulation.  Additionally, many whole life policies earn dividends, and you can use these dividends to accumulate additional cash value.

Additionally, you can add even more cash value to a whole life policy through the paid-up additions rider.  This is an elective rider you use to make discretionary payments to a whole life policy that will both enhance the policy's cash value as well as its death benefit.

All of the cash value in a whole life policy, regardless of how it got there, will grow over time through the guaranteed accumulation feature of the whole life policy.  This is essentially an interest rate paid each year by the insurance company on the current cash value in the policy.

Also, if you make use of the dividend option I briefly mentioned above, you accumulate additional cash value through the compounding of future whole life dividends.

How Cash Value Accumulates in a Universal Life Insurance Policy

All universal life insurance policies accumulate cash value through the payment of premiums above policy expenses.  Universal life insurance does not have a required premium amount like whole life insurance, instead, the policy owner is free to pay whatever amount he/she desires to the policy, up to the 7702 Test Limit.

Beyond premiums, the cash value also grows in a universal life insurance policy given some sort of interest payment or the accumulation in investment values held inside the universal life insurance policy.  For fixed-interest contracts (this includes traditional and indexed universal life insurance) the cash value will earn interest established by the insurance company or by an index feature.

For variable universal life insurance, the cash value will grow if the investment accounts held inside the policy appreciate in value.  These same cash values inside a variable contract will also go down if the investments decline in value.

Can you Withdraw the Cash Value in a Life Insurance Policy?

You can withdraw any paid-up addition/dividend addition cash value in a whole life policy and you can withdraw any cash value in a universal life insurance policy.

The important thing to understand here is that you cannot withdraw the base guaranteed cash value inside a whole life policy.  This is the cash value created by paying the required whole life premium.  There is a way to access this cash value while the policy remains in force, and I'll discuss that in the next section.

Withdrawing cash value from a life insurance policy will generally affect the death benefit of the policy.  You should be aware of this and prepared for the reduction in death benefit.  Many life insurers will take extra steps to alert you to this change in death benefit upon withdrawing money.  For whole life policies, the reduction in death benefit is usually a sum larger than the money withdrawn.  This happens because of the functionality of paid-up additions.  If you'd like a much more detailed explanation of why this happens, you should check out the Ultimate Guide to Paid-up Additions.

Many universal life insurance policies assess a small fee when you make a withdrawal from the policy.  Some insurers will waive this fee under certain circumstances.

Can you Take a Loan Against the Cash Value in a Life Insurance Policy?

You can take a loan against both universal and whole life insurance policies provided they currently have a cash value.  With whole life insurance, you can borrow against both guaranteed base whole life cash value and paid-up additions/dividend additions.  You can take a loan against all of the cash value in a universal life insurance policy.

Loans vary considerably from company to company on several key factors such as interest rate, the timing of interest charges, and if there is a waiting period after policy inception to use a loan or a specific type of loan.  This information is readily available to you by asking your agent or the life insurance company.

There are no additional fees on a life insurance policy loan.  I bring this up to contrast against the fee assessed on universal life insurance withdrawals.  If you take a loan, there is no fee.

Is the Cash Value in a Life Insurance Policy Taxable?

Generally speaking the cash value in a life insurance policy is only taxable if you surrender the policy, or withdraw a sum from the policy larger than your cost basis.

The cash value that remains inside a life insurance policy is not taxable.  Withdrawals from life insurance are tax-free provided they represent a recovery of your cost basis.  Loans taken against your cash value remain tax-free provided your policy is not a Modified Endowment Contract.

However, if you choose to surrender your life insurance policy for its cash value, you will owe taxes on the cash received in excess of the premiums you paid while the policy was in force.

Do you get the Cash Value in a Life Insurance Policy when you Cancel the Policy?

Yes, if you cancel your policy, you will receive its cash value.  This is one of the nonforfeiture benefits of a life insurance policy.  For universal life insurance, this is the only nonforfeiture benefit available.  For whole life insurance, you have two other options.

Once you surrender the policy and take the cash value, you are free to do with that cash whatever you wish.  You should understand that you may owe taxes on some of the money received (see the section immediately above).

You will receive a 1099 from the life insurance company at tax time immediately following a policy surrender.  The 1099 will state how much of the cash received is taxable–if any.

Do you get the Cash Value in a Life Insurance Policy when you Die?

For whole life insurance policies, you do not get the cash value in the policy when you die.  You will receive all of the death benefit, and for some policies, this will be a sum larger than your original death benefit plus the cash value of the policy.

Certain universal life insurance policies will give you the cash value of your policy as an additional death benefit upon death.  Setting up a universal life policy in this fashion does require some care to avoid circumstances that may be undesirable if you live to an advanced age.  Your best to discuss this feature of universal life insurance with an agent to obtain a better understanding of how it works and if you should do it.