If you’ve heard it once, you’ve heard it a million times: Life insurance is a must-have, especially when you have a family that depends on your income. If you die unexpectedly, a life insurance plan will ensure your family’s financial needs are covered, from the monthly mortgage to grocery bills to your child’s college education.
While income replacement is the primary purpose of life insurance, many policyholders tap into cash-value life insurance for other reasons, such as building a nest egg for retirement. Also known as permanent life insurance, cash-value life insurance policies provide both a death benefit and a cash-value accumulation during the policyholder’s lifetime.
With cash-value policies, policyholders can use the cash value in a variety of ways including:
- A tax-sheltered investment
- A means to pay policy premiums later in life
- A benefit they can pass on to their heirs
Whole life, variable life, and universal life all have a built-in cash value. Term life does not.
- Permanent life insurance policies offer cash-value accumulation and death benefits.
- Term life insurance does not offer a cash-value benefit.
- It is possible to use strategies like withdrawals or pay premiums to utilize your cash.
- Beneficiaries of these policies only receive the death benefits, not the cash-value accumulations.
Don't Throw Away Your Cash Value
Many policyholders do not make the most of the cash value in their permanent life policies, especially if they no longer need the death benefit. When the policyholder dies, their beneficiaries receive the death benefit, in lieu of any remaining cash value. But if there is no need to pass the death benefit on to beneficiaries any longer, the policyholder can access the accumulated cash value while still alive, either by surrendering the policy entirely or by making smaller withdrawals or policy loans.
Note that taking cash out of a policy will also reduce the death benefit. Taking a policy loan is a viable option if the policyholder needs cash at the moment but would like to keep the death benefit for the future, repaying the loan amount over time.
Below, we show you some options you have with your life insurance policy cash value, including six popular strategies to help you make the most of that cash value in your permanent life insurance.
Permanent life insurance offers both a death benefit and a cash-value amount but on death, beneficiaries only receive the death benefit. Any remaining cash value goes back to the insurance company.
Strategy 1: Boost the Death Benefit
If you have accumulated sizable cash value over the life of your permanent life insurance policy and do not intend to use these funds yourself, you may choose to leave a larger death benefit to your beneficiaries.
How can you pull that off? It’s usually very simple. Just call your life insurance company and say you’re interested in making a trade: You’d like to increase the death benefit in exchange for the cash value on your policy. Because the company doesn’t want to lose your business, it will more than likely accept your request.
During the trade, your objective should be to completely drain the cash value and transfer the full amount over to the death benefit or the face value. For example, if you have a universal life insurance policy with a $200,000 death benefit and $100,000 in cash value, your goal is to completely empty the cash value and boost the death benefit to $300,000. That’s $100,000 more that will fall into your heirs' hands instead of going to the life insurance company.
Strategy 2: Pay Life Insurance Premiums
Once you have accumulated enough cash value, you can tap into it to cover premium payments. This is known as being “paid up.” The vast majority of life insurance companies are willing to honor this request—all you have to do is ask. Using this tactic, you could save $2,000 or more in premiums each year.
Strategy 3: Take out a Loan
If you’ve built up a sizable cash value, you may also choose to take out a loan against your policy. Life insurance companies often offer these cash-value loans at interest rates lower than a traditional bank loan.
Of course, you’re not obligated to pay back the loan since you’re essentially borrowing your own money. However, it’s important to note that any money you borrow, plus interest, will be deducted from the death benefit when you die.
Strategy 4: Make a Withdrawal
If you’re low on funds or simply want to make a large purchase, you have the option to withdraw some or all of your cash value. Depending on your policy and the size of your cash value, such a withdrawal could chip away at your death benefit or even wipe it out altogether.
While some policies are reduced on a dollar-for-dollar basis with each withdrawal, others (such as some traditional whole life policies) actually reduce the death benefit by an amount greater than what you withdraw. Be sure to discuss this tactic with your insurance agent before you make any sudden moves.
Strategy 5: Grow Your Nest Egg
In recent years, cash-value life insurance policies have become extremely popular with investors looking to supplement their retirement income. If you have accumulated healthy cash value, you can use these funds in a variety of ways as an asset in your retirement portfolio. Often these funds are guaranteed to grow tax-deferred for many years, which could really beef up your nest egg.
Most advisors say policyholders should give their policy at least 10 to 15 years to grow before tapping into cash value for retirement income. Talk to your life insurance agent or financial advisor about whether this tactic is right for your situation.
Strategy 6: Full Surrender
Of course, you always have the option to surrender your policy and receive the accrued cash value. Before taking this route, it’s important to consider many factors. First and foremost, you’re relinquishing the death benefit when you surrender a life insurance policy, which means your heirs will receive nothing from the policy when you die. In most cases, you’ll also be charged surrender fees, which could greatly reduce your cash value.
Additionally, the cash you receive through the surrender is subject to income tax. If you have an outstanding loan balance against the policy, you could incur even more taxes.
The Bottom Line
Don't let the cash value accumulate in a permanent life insurance policy without deciding how you will use it. And make sure the cash value is drained and redeployed later in life, so it doesn't end up with the insurer after your death.