How Does Cash Value in Life Insurance Work
You most likely purchased life insurance for the financial protection it provides your loved ones in the event of your death — but there are some additional benefits to permanent life insurance. Some life insurance policies offer the opportunity to gain “cash value,” which is an element of your policy that may be borrowed against or paid out if the policy is surrendered* before death, otherwise known as a living benefit. Let’s take a closer look at how cash value in life insurance works.
What Is Cash Value In Life Insurance?
If you own a permanent life insurance policy, like American Family’s Whole Life insurance or MyLife Flexible insurance, your policy has the potential to build up cash value. Cash value is a facet of your life insurance policy that can accrue on a tax-deferred basis, meaning you don’t have to pay taxes on the growth while the cash value remains in your policy, but you might have to pay taxes if you withdraw the cash value**.
What Can You Do With Your Cash Value?
You can tap into your cash value for any purpose, including:
Taking out a loan. When you’ve built up enough cash value, you could take out a loan* against your policy. People might choose to borrow* against their policy to help with things like college tuition, a down payment on a home, emergencies, etc. Keep in mind, if you borrow against your policy, you’ll want to pay back the loan plus interest. Any unpaid loan and interest is subtracted from the proceeds at the time of death.
Withdrawals. Universal life policies may allow you to withdraw, free of tax, up to the surrender value of the policy*. Some companies charge surrender charges and taking a withdrawal could have additional consequences for your policy, so be sure to look at your contract or check with your agent before deciding to take a withdrawal.
Surrendering your contract. If you cancel your policy*, you’ll receive the accrued surrender value and can use the cash any way you want. But going this route means you may be charged surrender fees, which could reduce your cash value. And, if you surrender your policy for cash, the earnings could be subject to income tax.
Another important thing to note is when you surrender your policy, you may get the cash you need when you need it, but you’ll no longer have the death benefit, which is the guaranteed amount your beneficiaries would receive upon your death. Trying to replace that death benefit later by getting coverage again could be more expensive down the road or health changes could mean you wouldn’t qualify for a new policy, so be sure to talk with your insurance agent about the consequences of surrendering your policy.
Face Amount vs. Cash Value
You may have heard of the term “face amount” of life insurance, but don’t confuse this term with cash value. The face amount of life insurance is actually just another term for the coverage amount purchased. The death benefit is the amount that a named beneficiary receives upon the death of the insured. The death benefit could be equal to or less than the face amount (depending on things like outstanding loans on cash value). The cash value is an entirely separate benefit within the same policy.
In fact, a premium for a permanent life insurance policy is actually more expensive than a term policy premium because part of the premium goes towards paying for the death benefit, while a portion goes towards the cash value growth. In the early stages of your policy, a higher percentage of your premium goes toward the cash value.
It’s important to understand the options of cash value in a life insurance policy so you know how to best utilize the benefits. Talk with your American Family Insurance agent to learn more about how permanent life insurance and cash value works. And, check out our life insurance coverages to see which options are best for you and your loved ones.
Check out our life insurance glossary of terms to get savvy on life insurance terminology.
*Disclaimer: Any loans taken from your life insurance policy will accrue interest. An outstanding loan balance (loan plus interest) will be deducted from the death benefit at the time of claim. If the loan balance grows too large for the cash value to support it, the policy could terminate. Partial surrenders may affect the death benefit and could require additional premiums to keep the policy in force.
**Disclaimer: Neither American Family Life Insurance Company nor its agents are authorized to give tax or legal advice, and this should not be construed as such advice.