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

Not all life insurance policies have cash value. Term life insurance — the cheapest kind — has no cash value at all. You pay a monthly premium, and if you die during the term (usually 10, 20, or 30 years), your beneficiary gets the death benefit. When the term ends, the policy ends. You get nothing back.

Permanent life insurance — which includes whole life, universal life, and variable universal life — builds cash value. Part of your premium goes toward the death benefit, and part goes into an account that grows over time. That growing account is the cash value. After a few years, you can borrow from it, withdraw from it, or use it to pay your premiums.

Cash value grows tax-deferred, meaning you don't pay taxes on the growth while the money sits in the policy. But the moment you withdraw or borrow it, tax rules apply — and they vary depending on how much you've taken out and how long you've held the policy.

Key Takeaways

  • Cash value only exists in permanent life insurance policies (whole life, universal life, variable universal life), not in term life insurance.
  • You can borrow against cash value during your lifetime, and the loan does not count as income for tax purposes if the loan amount is less than what you've paid in premiums.
  • Withdrawing cash value above what you've paid in premiums triggers income tax on the gain, and withdrawals reduce your death benefit unless you repay the amount.
  • Cash value grows slowly in the first few years because insurance company fees and commissions eat into your premiums, so cashing out early usually means losing money.
  • If you stop paying premiums, the insurance company can use your cash value to keep the policy in force, or you can surrender the policy and receive the remaining cash value minus any surrender charges.

How cash value grows inside your policy

When you pay a premium on a permanent life insurance policy, the insurance company splits that money into pieces. Some covers the cost of the death benefit itself (the risk the insurer takes on). Some goes to the insurance company's profit and overhead. The rest goes into your cash value account.

In the early years, very little reaches your cash value because the insurance company's costs are front-loaded. Commissions to the agent, underwriting, medical exams, and administrative setup all happen upfront. This is why surrendering a policy in year two or three almost always means getting back less than you paid in.

Over time, as those one-time costs are absorbed, a larger share of your premium feeds the cash value. The money inside grows at a rate set by your policy type. Whole life policies earn a may provide minimum rate plus potential dividends. Universal life policies are tied to market interest rates. Variable universal life lets you direct the cash value into investment subaccounts, similar to a 401(k).

Borrowing against cash value versus withdrawing it

A policy loan lets you borrow money from your cash value without surrendering the policy. You keep your death benefit intact, and you don't owe income tax on the loan itself — the IRS treats it as a loan, not income. You do pay interest on the loan, usually at a rate set in your policy (often 5% to 8%, though it varies). If you die before repaying the loan, the insurance company deducts what you owe from the death benefit your beneficiary receives.

A withdrawal is different. You take cash out and keep it. Withdrawals are tax-free up to the amount of premiums you've paid in. Anything above that is taxed as ordinary income. For example, if you've paid $50,000 in premiums and your cash value is now $70,000, you can withdraw $50,000 tax-free, but the $20,000 gain is taxable. Withdrawals also reduce your death benefit dollar-for-dollar unless you repay the amount.

Most people who need cash choose a loan over a withdrawal because the loan preserves the death benefit and avoids the tax hit on gains. But loans do cost interest, and if you die with an outstanding loan, your family receives less.

Why cash value grows slowly in the first years

If you buy a $500,000 whole life policy at age 40, you might pay $400 per month. In year one, your cash value might only be $2,000 to $3,000 — less than 10% of what you paid in. This shocks many people, but it's how the system works.

The insurance company's costs are steepest at the start. The agent's commission is often 50% to 110% of your first-year premium. Underwriting, medical records, and policy setup are one-time expenses. The company also builds in profit. All of this comes out before cash value is funded.

By year 10, the picture improves. Those upfront costs are long gone, and a much larger share of your premium goes to cash value. By year 20 or 30, cash value can grow substantially. But if you surrender the policy in year 3 or 4, you'll almost certainly get back less than you paid, even though you've been making payments for years.

Surrender charges and what happens if you stop paying

When you buy a permanent life insurance policy, you agree to a surrender period — usually 10 to 15 years. During this time, if you cancel the policy and take the cash value, the insurance company charges a surrender fee. This fee starts high (sometimes 10% of cash value in year one) and declines each year until it reaches zero.

If you stop paying premiums before the surrender period ends, the insurance company can use your cash value to keep the policy in force. This is called automatic premium loan or non-forfeiture. The company essentially loans you the premium from your own cash value, and the loan accrues interest. Eventually, if you never pay again, the cash value runs out and the policy lapses.

Alternatively, you can formally surrender the policy and receive whatever cash value remains after the surrender charge. Once you surrender, the policy is gone — there's no death benefit for your beneficiaries anymore.

Tax rules for cash value withdrawals and loans

The tax treatment of cash value depends on whether you're borrowing or withdrawing, and how much you've paid in premiums versus how much the policy has grown.

Policy loans are not taxable income. You can borrow as much as your cash value allows without filing anything extra on your tax return. The only tax consequence is if you die with an outstanding loan — your beneficiary's death benefit is reduced by the loan amount plus any unpaid interest.

Withdrawals are taxed on the gain only. If you've paid $60,000 in premiums and your cash value is $85,000, you can withdraw $60,000 with no tax. The $25,000 gain is taxable as ordinary income in the year you withdraw it. If you withdraw more than your basis (premiums paid), the excess is taxed immediately.

If your policy is a modified endowment contract (MEC) — a policy that received too much money too fast — the tax rules are harsher. Withdrawals from an MEC are taxed on gains first, and if you're under 59½, you also pay a 10% penalty on the taxable portion. This is rare for standard policies but can happen if you make large lump-sum payments early on.

When cash value makes sense and when it doesn't

Cash value is useful if you want life insurance that lasts your entire life and you can afford the higher premiums. Whole life policies cost 10 to 15 times more per month than term life, but they never expire and they build an asset you can access. If you're wealthy and want permanent coverage plus a tax-deferred savings vehicle, permanent life insurance can make sense.

Cash value is usually not worth the cost if you need coverage for a specific period — like until your kids finish college or your mortgage is paid off. Term life is far cheaper and does the job. You can buy a 20-year term policy for a fraction of what permanent life costs, and if you don't need coverage after 20 years, you haven't wasted money on cash value that never grew enough to matter.

Cash value also doesn't make sense as an investment strategy. The returns are modest — often 2% to 4% annually after fees — and you're paying for insurance on top of that. A regular investment account or 401(k) will almost always outpace cash value growth, and you won't have insurance costs eating into your returns.

Frequently Asked Questions

Can I use my cash value to pay my premiums?

Yes. If you stop making premium payments, most permanent policies automatically use your cash value to cover the monthly cost. This is called automatic premium loan or non-forfeiture. The policy stays in force as long as cash value lasts. Once the cash value runs out, the policy lapses and your death benefit ends.

What happens to cash value if I die?

Your beneficiary receives the death benefit, not the cash value. The cash value stays with the insurance company. This is why permanent life insurance is more expensive — you're paying for both the death benefit and the cash value account, but your heirs only get the death benefit. The cash value is a benefit for you during your lifetime, not for them after you die.

Can I borrow from my cash value if I have bad credit?

Yes. Policy loans don't require a credit check or approval process. You can borrow up to your cash value (sometimes slightly less) simply by requesting it from your insurance company. The loan is secured by your own cash value, so credit history doesn't matter. Interest rates are set in your policy and don't change based on your credit score.

Is cash value the same as the death benefit?

No. The death benefit is what your beneficiary receives when you die. Cash value is money you can access while alive. They are separate. If you have a $500,000 death benefit and $50,000 in cash value, your beneficiary gets $500,000 when you pass. The $50,000 stays with the insurance company.

What's the difference between cash value and surrender value?

Cash value is the total amount your policy has accumulated. Surrender value is what you actually receive if you cancel the policy — cash value minus any surrender charges. In early years, surrender charges can be steep, so surrender value may be much lower than cash value. After the surrender period ends, surrender value equals cash value.