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What is 'Cash-Value Life Insurance'

Cash-value life insurance is a type of life insurance policy that pays out upon the policyholder's death, and also accumulates value during the policyholder's lifetime. The policyholder can use the cash value as a tax-sheltered investment (the interest and earnings on the policy are not taxable), as a fund from which to borrow and as a means to pay policy premiums later in life, or they can pass it on to their heirs.

BREAKING DOWN 'Cash-Value Life Insurance'

Whole life, variable life and universal life are all types of cash-value life insurance. Cash-value insurance is also known as permanent life insurance because it provides coverage for the policyholder's entire life. The other major category of life insurance is called term insurance, because it is generally in force only for a period of 10 to 30 years or until the policyholder cancels it. Cash-value insurance has higher premiums than term insurance because part of the premium pays for the death benefit coverage and part of it goes toward the policy's cash value.

How Cash-Value Life Insurance Works

Cash-value life insurance is designed as a permanent form of life insurance that includes a death benefit component and a savings component. Most cash-value life insurance policies require a fixed level premium payment, a portion of which is applied to insurance costs with the balance deposited into a cash-value account. The cash-value account earns a modest rate of interest which is allowed to accumulate tax-free.

Over time, the cash-value account grows, which reduces the mortality risk of the life insurer. That is because, upon the death of the insured, the insurer is only obligated to pay the death benefit, not the cash value, which it retains. The decreasing mortality risk is also the reason why the insurer is able to guarantee a fixed, level premium for the life of the insured.

Cash-Value as a Living Benefit

Owners of a cash-value life insurance policy can benefit from savings that accumulate in the cash-value account. Cash-value savings can be accessed in a number of ways. With some types of policies, the cash value can be withdrawn. Withdrawals are tax-free to the extent they don’t exceed the total amount of premiums deposited into the policy. However, withdrawals can have the effect of decreasing the death benefit amount.

Most cash-value policies allow for loans to be taken from the cash-value. Loans will also decrease the death benefit amount. Although there is no requirement for the loans to be repaid, the death benefit is reduced by the loan amount. Loans do accrue interest, which can reduce both the cash-value balance and the death benefit further.

Cash-value can also be used to pay the policy premiums. If there is sufficient cash-value, a policyholder can stop paying for premiums out-of-pocket for the life of the policy.

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