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Updated July 28, 2023 Reviewed by Reviewed by Thomas J. CatalanoThomas J Catalano is a CFP and Registered Investment Adviser with the state of South Carolina, where he launched his own financial advisory firm in 2018. Thomas' experience gives him expertise in a variety of areas including investments, retirement, insurance, and financial planning.
Cash value life insurance, also known as permanent life insurance, includes a cash component in addition to a death benefit, which is intended to be a tool to help protect your loved ones from financial strain in the event of your death.
You typically also can access this cash value before your policy ends, such as by taking out a loan to pay for other life expenses. Cash value can accumulate in your permanent life insurance policy in several ways, depending on the type of policy you have and each individual life insurance company. Let's look at how the cash accumulation process typically works.
When you make premium payments on a cash value life insurance policy, one portion of the payment is allotted to the policy’s death benefit (based on your age, health, and other underwriting factors). Another portion covers the insurance company’s operating costs and profits. The rest of the premium payment goes toward your policy’s cash value.
In most cases, cash value doesn't accrue for two to five years. The life insurance company generally invests this money in a conservative-yield investment. As you continue to pay premiums on the policy and earn more interest, the cash value grows over the years.
The rate of return you earn within a cash value policy can be fixed, as in the case with whole life insurance, or it can depend on how premium payments are invested, as in the case with universal life insurance.
Once you've begun accumulating cash value in a life insurance policy, you can use these funds to:
In the early years of the policy, a higher percentage of your premium goes toward the cash value. Over time, the amount allotted to cash value decreases.
Each year as you grow older, the cost of insuring your life gets more expensive for the life insurance company. This is why the older you are, the more it costs to purchase a new life insurance policy of any type. When it comes to cash value insurance, the insurance company factors in these increasing costs.
In the early years of your insurance policy, a larger portion of your premium is invested and allocated to the cash value account. Generally, this cash value can grow quickly in the early years of the policy. Then in later years, the cash value accumulation slows as you grow older and more of the premium is applied to the cost of insurance. How this ultimately works out depends on the type of policy.
Your cash value balance also grows by the return offered by your type of policy. The larger your balance, the more it can earn. You typically have a larger balance as you get older because you've had the policy for longer, which leads to larger earnings. Whether this is enough to outweigh the higher insurance costs depends on your individual policy.
Your insurer can give you a life insurance illustration predicting your cash value accumulation over time. That way you can see the expected result before signing up.
Consult an insurance advisor to determine how to calculate potential cash value accumulation of your specific permanent life insurance policy.
Cash value accumulation isn't uniform. It varies depending on the type of policy you have.
Each type of policy carries a different level of risk. With whole life policies, you're generally taking the least risk because your cash value accumulation is guaranteed. Variable life policies, on the other hand, are more risky because they depend on the performance of an asset.
It's crucial to understand how cash value accumulation and risk correlate so you can choose a policy that fits your risk tolerance.
Let’s say, hypothetically, that you purchase a whole life policy with a $1 million fixed, or level, death benefit when you’re 25. You consistently pay your monthly premium of $1,562, and every month a percentage of that payment goes toward the cash value of your policy, starting from the second policy year onward. (See table below.)
Thirty years after you purchase the policy, you’re 55 years old, and your cash value account has grown to $500,000. Because the policy offers a $1 million death benefit and you already have a cash value of $500,000, the insurance costs must cover the remaining $500,000.
Ten years later, when you are 65, your policy’s cash value has grown to $750,000. As you are older, the cost of insuring your life is higher. However, when you factor in your significant cash value, the policy is really only insuring $250,000. The rest of the death benefit the policy will pay will come from the cash value.
| Whole Life, Fixed Death Benefit $1 Million Policy's Premium Allocation | ||||
|---|---|---|---|---|
| Policy Year | Policyholder Age | Amount of Cash Value | Insurance Costs | Level Death Benefit |
| 1 | 25 | $0 | $1,388 | $1,000,000 |
| 30 | 55 | $500,000 | $500,000 | $1,000,000 |
| 40 | 65 | $750,000 | $250,000 | $1,000,000 |
How annual premium is divided for a whole life policy with a fixed, or level, death benefit, over 40 years for 25-year-old non-smoking female.
This is a simplified example. The actual numbers will vary significantly depending on the life insurance company, the type of policy you purchase, and, in some cases, current interest rates. For this reason, it's important to research which of the best life insurance companies for you will offer the most cash value for your investment.
Take advantage of the cash value that has built up in your policy. This is critical because at the time of your death, the cash value in your policy goes back to the insurance company, not your heirs, who will receive only the death benefit.
Here is detailed hypothetical example of how cash value accumulates over time. The chart below provides a closer look at how cash value accumulation can work within a whole life policy that has a fixed, or level, death benefit, assuming all premiums are paid out-of-pocket.
| Whole Life (Fixed Death Benefit) Cash Value Accumulation for a $100,000 Policy | |||
|---|---|---|---|
| Policy Year | Age | Annual Premiums | Cash Value |
| 5 | 40 | $1,178 | $3,738 |
| 10 | 45 | $1,178 | $11,569 |
| 20 | 55 | $1,178 | $33,838 |
| 30 | 65 | $1,178 | $72,398 |
| 35 | 70 | $1,178 | $99,839 |
| 50 | 85 | $1,178 | $228,317 |
| 55 | 90 | $1,178 | $289,301 |
Cash value accumulation for a whole life policy with a fixed, or level, death benefit, with premiums paid out-of-pocket starting at age 35 for a non-smoking male.
Cash value can accumulate at different rates in life insurance, depending on how the policy works and market conditions. For example, cash value builds at a fixed rate with whole life insurance. With universal life insurance, the cash value is invested and the rate that it increases depends on how well those investments perform.
Whole life insurance, universal life insurance, and variable life insurance are types of life insurance that can build a cash value. Term life insurance, which is for a set period of time, doesn't build cash value.
You can withdraw cash value from any permanent life policy, including whole life, before your death. Be aware that when you make a withdrawal, your death benefit will likely be reduced. You can also cancel your policy and take the cash value, minus any surrender charges. Finally, you can take out loans against your cash value.
When you have a permanent life insurance policy, the cash value in it builds up as a result of the fixed premiums you pay in being split into three categories. One portion of your premium goes toward the death benefit, another part is channeled toward the insurer's costs and profits, and the third increases the policy's cash value. However, it's important to understand that the funds allotted to cash decrease and those paid to cover insurance increase as you age.
Different kinds of whole life policies carry varying levels of risk when it comes to cash value accumulation. If you obtain a whole life policy, it usually poses the least risk with guaranteed cash value accumulation. Variable life policies are more risky because they depend on the performance of an asset but may produce greater cash value over time.