Cash value is money that builds up inside certain life insurance policies and belongs to you

Not all life insurance policies have cash value. Term life insurance — the kind that covers you for a set number of years — has no cash value. When the term ends, the policy ends and you get nothing back. Permanent life insurance — policies designed to last your whole life — builds cash value over time. A portion of your premium payment goes toward the death benefit your beneficiaries will receive, and another portion goes into a cash account that grows.

You own this cash value. You can borrow against it, withdraw it, or use it to pay premiums if you stop making payments. If you cancel the policy, the insurance company sends you the cash value minus any outstanding loans. This is different from term insurance, where cancellation means you simply stop paying and get nothing in return.

Key Takeaways

  • Cash value only exists in permanent life insurance policies, not in term policies.
  • The cash value grows tax-deferred, meaning you do not pay taxes on the growth while the money sits in the policy.
  • You can borrow money from your cash value at a rate set by the insurance company, and the loan does not require a credit check.
  • If you withdraw cash value, the amount you take out reduces your death benefit dollar-for-dollar unless you repay it.
  • Surrendering a policy for its cash value ends your coverage completely and may trigger taxes on gains above what you paid in premiums.

How cash value accumulates inside the policy

When you pay a premium on a permanent life insurance policy, the insurance company divides that money into pieces. Some goes to pay the cost of insurance itself — the risk the company takes on by insuring you. Some goes to administrative costs. The rest goes into the cash value account, where it grows according to the policy type.

In a whole life policy, the insurance company guarantees a minimum interest rate on your cash value, usually between 1 and 3 percent. The company may also pay dividends — a share of profits — which can increase the cash value faster. In a universal life policy, your cash value earns interest based on current market rates, so growth varies year to year. In a variable universal life policy, you direct the cash value into investment accounts similar to mutual funds, and growth depends on how those investments perform.

Cash value grows slowly at first. In the early years of the policy, most of your premium goes toward the cost of insurance and fees, not into the cash account. As you age and the cost of insurance rises, the insurance company needs less of your premium to cover that cost, so more money flows into cash value. This is why cash value typically accelerates in the middle years of the policy.

Borrowing against your cash value

Once your cash value reaches a certain amount — usually after two to five years — you can borrow from it. The insurance company lends you money using the cash value as collateral. You pay interest on the loan, but the rate is set by the policy, not by the market, so it does not change based on your credit score or financial situation.

The loan does not require approval in the traditional sense. The insurance company cannot deny you because you have a poor credit history or unstable income. If you have cash value, you can borrow. The loan also does not appear on your credit report, so it does not affect your ability to borrow from banks or other lenders.

If you do not repay the loan, the insurance company deducts it from the death benefit your beneficiaries receive. If the loan grows larger than the cash value through unpaid interest, the policy can lapse — meaning your coverage ends. This is a real risk: if you borrow heavily and stop paying premiums, the policy may terminate and you lose your life insurance.

Withdrawing cash value versus surrendering the policy

You can take money out of your cash value without borrowing. A withdrawal is different from a loan: you receive the money outright, but the amount you withdraw reduces your death benefit. If your policy has a $500,000 death benefit and $100,000 in cash value, and you withdraw $30,000, your death benefit drops to $470,000.

Withdrawals up to the amount you have paid in premiums are not taxed. If you paid $50,000 in premiums over the years and your cash value is now $80,000, you can withdraw $50,000 tax-free. Anything above that is considered a gain, and the IRS taxes it as ordinary income in the year you withdraw it.

Surrendering the policy means canceling it entirely and taking all the remaining cash value. Once you surrender, your life insurance coverage ends completely. If you surrender and the cash value exceeds what you paid in premiums, you owe income tax on the difference. Some policies also charge a surrender fee if you cancel within the first 10 to 15 years, which reduces the amount you receive.

Why cash value matters for policy costs

Cash value can help you keep a policy in force if your circumstances change. If you lose your job or face a financial hardship and cannot pay premiums, you can use the cash value to cover the payments automatically. Many policies allow this without requiring you to ask — the insurance company simply deducts the premium from your cash account each month.

This feature can prevent your policy from lapsing. A lapsed policy means you lose your coverage, and if you want to buy life insurance again later, you may face higher premiums because you are older or your health may have changed. By using cash value to keep the policy active, you preserve the coverage you locked in at your original age and health status.

Cash value also means permanent life insurance costs more than term insurance. You are paying for both the death benefit and the cash account. If you only need coverage for a specific period — such as until your children finish college or your mortgage is paid off — term insurance is usually cheaper. If you want coverage that lasts your whole life and want the flexibility of borrowing or withdrawing, permanent insurance with cash value makes sense.

Tax treatment of cash value

The money inside your cash value account grows tax-deferred. You do not pay taxes on the interest or investment gains each year the way you would with a regular savings account or brokerage account. The taxes are deferred until you withdraw the money or surrender the policy.

When you die, your beneficiaries receive the death benefit tax-free. The cash value is part of that death benefit, so they do not owe income tax on it. However, if your total life insurance death benefits are very large — over $12.92 million in 2023, though this threshold changes yearly — your estate may owe federal estate tax. This is a concern only for people with substantial wealth, not for most policyholders.

If you borrow from your cash value and do not repay the loan before you die, the insurance company deducts the outstanding loan balance from the death benefit your beneficiaries receive. This reduces what they get, but they still do not owe income tax on the remaining amount.

When cash value policies make sense

Permanent life insurance with cash value is most useful if you need coverage beyond a specific term and want the flexibility to access money during your lifetime. Some people use it as a supplemental savings tool, though the returns are typically modest compared to other investments. Others value the forced discipline of regular premium payments and the may provide that the money will be there if they need it.

Cash value policies are also useful if you have dependents who will need support for your entire life, not just for 20 or 30 years. If you have a child with special needs who will require financial support indefinitely, or if you want to leave a legacy to your family or charity, permanent insurance can be the right choice.

The trade-off is cost. Permanent insurance premiums are significantly higher than term insurance for the same death benefit. You need to decide whether the cash value feature and lifetime coverage are worth the extra expense in your situation.

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 borrows from your cash value to pay the premium if you miss a payment. This keeps your policy active without requiring you to take action. However, the loan accrues interest, so your cash value decreases over time if you rely on this feature regularly.

What happens to cash value if I stop paying premiums?

If you stop paying and do not use the automatic premium loan feature, your policy will lapse after a grace period, usually 30 to 60 days. Once it lapses, your coverage ends. Some policies allow you to reinstate coverage within a set time frame if you pay back-due premiums, but this depends on the policy terms.

Is the cash value may provide to grow?

In whole life policies, the insurance company guarantees a minimum interest rate, so your cash value will grow at least that much. In universal life and variable universal life policies, growth is not may provide and depends on interest rates or investment performance. Check your policy documents to see what guarantees apply to your specific policy.

Do I have to pay taxes on a policy loan?

No. A loan is not income, so you do not owe taxes when you borrow. However, if the loan is not repaid before you die, the insurance company deducts it from the death benefit, which reduces what your beneficiaries receive.

Can I borrow more than my cash value?

No. You can only borrow up to the amount of cash value in your policy. If you try to borrow more, the insurance company will deny the request. If you need more money, you would have to surrender the policy and take the entire cash value, which ends your coverage.