Cash value is money your life insurance policy accumulates over time that you can borrow against or withdraw while you're still alive

Not all life insurance policies build cash value. Term life insurance — the cheapest option — has no cash value at all. You pay a monthly premium for a set number of years (10, 20, or 30 years), and if you die during that term, your beneficiary gets the death benefit. When the term ends, the policy ends with it.

Permanent life insurance — which includes whole life, universal life, and variable universal life — does build cash value. Part of your premium goes toward the death benefit, and part goes into an account that grows over time. You can borrow from this account, withdraw from it, or use it to pay premiums later. The insurance company also charges fees and interest, which is why cash value grows slowly at first.

Cash value is separate from your death benefit. If you die, your beneficiary receives the death benefit amount, not the cash value. The insurance company keeps the cash value to offset what they pay out.

Key Takeaways

  • Only permanent life insurance policies (whole life, universal life, variable universal life) build cash value; term life insurance does not.
  • You can borrow against your cash value during your lifetime, and the loan does not count as income for tax purposes.
  • Cash value grows tax-deferred, meaning you do not pay taxes on the growth until you withdraw money beyond what you paid in premiums.
  • Withdrawing cash value reduces your death benefit dollar-for-dollar, while borrowing against it does not affect the death benefit unless you do not repay the loan.
  • Permanent life insurance costs significantly more than term life insurance because you are paying for both the death benefit and the cash value account.

How cash value grows inside your policy

When you pay your premium on a permanent life insurance policy, the insurance company divides it into pieces. One piece covers the actual cost of insuring your life (the mortality cost). Another piece goes into the cash value account. The rest covers the company's overhead and profit.

In the first year or two, your cash value grows very slowly because most of your premium is eaten by fees and commissions. After that, the cash value grows at a rate set by your policy type. With whole life insurance, the insurance company guarantees a minimum interest rate — typically 2 to 4 percent — and may add dividends on top if the company performs well. With universal life insurance, the rate is usually tied to market indexes or interest rates and can fluctuate. With variable universal life, you choose how the cash value is invested, similar to a 401(k), so growth depends on your investment choices.

The longer you keep the policy, the more cash value accumulates. By year 10 or 15, the cash value can be substantial. By year 20 or 30, it may rival or exceed the annual premiums you have paid.

Borrowing against cash value versus withdrawing it

You have two ways to access your cash value while the policy is active: borrow against it or withdraw it. The choice matters because they work differently and have different consequences.

When you borrow against cash value, the insurance company lends you money using your cash value as collateral. You do not lose the cash value — it stays in your account and continues to grow. You pay interest on the loan, usually at a rate set by your policy (often 5 to 8 percent). If you die before repaying the loan, the insurance company subtracts what you owe from the death benefit your beneficiary receives. Loans are not taxable income.

When you withdraw cash value, you take money out of the account permanently. Your cash value shrinks by the amount you withdraw. Your death benefit also shrinks by the same amount, unless your policy allows the death benefit to stay level (some policies do). Withdrawals up to the amount you paid in premiums are not taxable. Withdrawals beyond that are taxed as ordinary income. If you withdraw too much, your policy can lapse and you lose the death benefit entirely.

Tax treatment of cash value

The growth inside your cash value account is tax-deferred, meaning you do not pay taxes on it while it sits in the policy. This is one advantage permanent life insurance has over regular savings accounts or taxable investments.

When you withdraw or borrow, the tax picture changes. Loans have no tax consequence — you borrowed money, not earned it. Withdrawals are taxed only on the amount above your cost basis (the total premiums you paid). If you paid $50,000 in premiums and your cash value is now $70,000, you can withdraw $50,000 tax-free. Any withdrawal above $50,000 is taxed as ordinary income at your regular tax rate.

If your policy lapses or you surrender it (cancel it), any remaining cash value above your cost basis is taxed in the year the policy ends. This is why surrendering a policy late in life can create a large tax bill.

When cash value makes sense and when it does not

Cash value is useful if you want life insurance that does not expire and you can afford the higher premiums. Whole life insurance, for example, lasts your entire life as long as you pay premiums, and the cash value gives you a way to access money in an emergency without taking out a loan from a bank.

Cash value is less useful if you only need life insurance for a specific period — while your kids are young, while you have a mortgage, or while you are the main earner in your household. In those cases, term life insurance is much cheaper and does the job. You can buy a 20-year or 30-year term policy for a fraction of what permanent insurance costs, and use the money you save to build your own savings account.

Cash value also makes less sense if you are unlikely to use it. If you never borrow against it and never surrender the policy, the cash value is just extra cost you are paying for a benefit you do not receive. The insurance company keeps it when you die.

What happens to cash value if you stop paying premiums

If you stop paying premiums on a permanent life insurance policy, the insurance company can use your cash value to cover the cost of keeping the policy in force. This is called a policy loan or automatic premium loan, depending on your policy terms.

As long as your cash value is large enough to cover the monthly or annual premium, your policy stays active and your death benefit remains in place. Your cash value shrinks each month as premiums are deducted from it. Eventually, if your cash value runs out, your policy lapses and you lose the death benefit.

Some policies allow you to reduce the death benefit to lower the premium, which stretches your cash value further. Others let you convert to a paid-up policy, where you stop paying premiums but keep a smaller death benefit for life. The exact options depend on your specific policy.

Comparing cash value across policy types

The type of permanent insurance you choose affects how fast cash value grows and how much control you have over it.

Whole life offers predictable growth with a may provide minimum interest rate plus potential dividends. The tradeoff is higher premiums and less control — the insurance company decides how the money is invested. Universal life offers lower premiums and more flexibility — you can adjust your death benefit and premium payments as your needs change — but the interest rate can drop if market conditions worsen. Variable universal life gives you the most control because you choose how the cash value is invested, but you also bear the investment risk and the policy is more complex.

All three types allow you to borrow or withdraw, but the fees and interest rates vary. Before buying permanent life insurance, compare the projected cash value at year 10 and year 20 across different policies and companies. A policy with lower premiums may have slower cash value growth due to higher fees.

Frequently Asked Questions

Can I use my cash value to pay my premiums?

Yes. Most permanent policies allow automatic premium loans, where the insurance company deducts your premium from your cash value each month or year. Your cash value shrinks, but your policy stays active. If your cash value runs out, your policy lapses unless you resume paying premiums yourself.

Is borrowing against cash value better than taking a personal loan?

It depends on the interest rate and your situation. Policy loans typically charge 5 to 8 percent interest, which is often lower than personal loans or credit cards. You also do not have to may have access to or go through a credit check. The downside is that unpaid loans reduce your death benefit, and if you die with an outstanding loan, your beneficiary receives less.

What happens to cash value if I surrender my policy?

When you surrender (cancel) a permanent life insurance policy, the insurance company pays you the cash value minus any outstanding loans. You lose the death benefit. Any cash value above the premiums you paid is taxed as ordinary income in that year, which can create a large tax bill if you surrender late in life.

Does cash value earn interest if I do not borrow or withdraw?

Yes. Cash value continues to grow at the rate may provide or projected by your policy, whether you touch it or not. The growth is tax-deferred. However, the insurance company charges fees and mortality costs each year, which slow the growth compared to what you might earn in other investments.

Can I access my cash value if my policy lapses?

If your policy lapses because you stopped paying premiums and your cash value ran out, you cannot access it — the insurance company keeps it. If you surrender the policy before it lapses, you can withdraw the remaining cash value. This is why it is important to understand your policy's lapse rules and keep track of your cash value balance.