Cash value is the feature that makes whole life insurance different from term. It’s also the part people find most confusing. Is it savings? An investment? Something you get back? The answer is a little of each, with rules. Here’s how whole life cash value works, in plain English.
Quick takeaway
- Whole life policies build cash value according to a schedule in the contract, alongside a death benefit that lasts for life.
- Cash value usually grows slowly in the early years, because premiums also cover insurance costs and expenses.
- You can typically borrow against cash value or surrender the policy for it, but both reduce what your beneficiaries receive.
- Ask for an illustration that shows guaranteed values separately from any non-guaranteed values.
The basics
Whole life insurance is permanent coverage. As long as required premiums are paid, it’s designed to last your whole life and pay a death benefit when you die. Most whole life policies have level premiums, meaning the premium doesn’t rise as you age.
Part of each premium pays for the insurance itself and the insurer’s costs. Another part goes toward the policy’s cash value, which grows over time according to the contract. In a traditional whole life policy, the insurer guarantees a minimum cash value schedule, shown in your policy and illustration.
Why cash value exists
Level premiums are part of the reason. When you’re young, your level premium is higher than the actual cost of insuring you that year. In later years, it’s lower than the actual cost. The extra paid early is held in the policy as reserves, which is reflected in the cash value. That’s how a whole life policy can keep the same premium for decades.
Why it grows slowly at first
In the early years of a whole life policy, cash value is often small compared with what you’ve paid in. Premiums in those years also cover underwriting, policy setup, sales commissions, and other costs. Over time, the cash value typically grows faster as those early costs are behind you and the guaranteed growth compounds.
That’s why whole life generally works best as a long-term commitment. If you surrender a policy in the first several years, you may get back much less than you paid.
Guaranteed and non-guaranteed values
A whole life illustration usually shows two sets of numbers:
- Guaranteed values: the minimum cash value and death benefit the contract promises if you pay the required premiums.
- Non-guaranteed values: projections that include possible dividends or other elements the insurer doesn’t guarantee.
The NAIC’s Life Insurance Illustrations Model Regulation calls for illustrations to label non-guaranteed elements and to state that benefits and values shown are not guaranteed and that actual results may be more or less favorable. Focus on the guaranteed column when deciding whether you can live with the policy. Our article on whole life dividends explains the non-guaranteed side.
How you can use cash value
Borrow against it
Many whole life policies let you take a policy loan using your cash value as collateral. You don’t need a credit check, and you can usually repay on your own schedule. But interest is charged, and unpaid loans and interest reduce the death benefit. If the loan balance grows too large, the policy can lapse. See our guide to life insurance policy loans.
Surrender the policy
You can cancel the policy and receive the cash surrender value, which is the cash value minus any surrender charges and outstanding loans. Once surrendered, the coverage ends.
Pay premiums
Some policies let you use cash value or dividends to help pay premiums. Depending on how a policy is designed and funded, this may reduce or replace out-of-pocket premiums later. Results depend on non-guaranteed elements in many cases, so ask how it would work under guaranteed values.
Reduced paid-up coverage
Many policies let you stop paying premiums and use the cash value to buy a smaller, fully paid-up policy. It’s one way to keep some coverage if you can’t keep paying.
Taxes, in general terms
Under current federal tax law, cash value in a life insurance policy generally grows without being taxed each year. Withdrawals, loans, surrenders, and lapses can have tax consequences, especially if you’ve taken out more than you paid in. Policies that are funded too heavily in the early years can become a modified endowment contract (MEC) under 26 U.S.C. § 7702A, which changes how withdrawals and loans are taxed. Talk to a tax professional before relying on any tax treatment.
Is cash value “worth it”?
It depends on your goals. Whole life costs much more than term for the same death benefit. Cash value can make sense if you want:
- Lifelong coverage, for final expenses, a spouse, or a legacy
- Guaranteed values and level premiums
- A conservative, long-term place to build value you can borrow against
It may be less helpful if you need the most coverage for the lowest cost during your working years, or if you might drop the policy early.
Questions to ask before buying
- What are the guaranteed cash values in years 5, 10, 20, and at age 65?
- What are the surrender charges, and how long do they last?
- How much of the illustration depends on non-guaranteed dividends?
- What’s the policy loan interest rate, and is it fixed or variable?
- Could the way I plan to fund it make it a MEC?
Frequently asked questions
How does cash value grow in whole life insurance?
In a traditional whole life policy, cash value grows according to a guaranteed schedule in the contract. Participating policies may also add non-guaranteed dividends.
Can I withdraw cash value from whole life?
Many policies allow loans against cash value, and you can surrender the policy for its cash surrender value. Some participating policies also allow surrendering paid-up additions. Each option can reduce the death benefit.
Why is my cash value so low in the first years?
Early premiums also cover insurance costs, setup, and commissions, so cash value usually builds slowly at first and faster over time.
Do beneficiaries get the cash value and the death benefit?
In a typical whole life policy, beneficiaries receive the death benefit, not the cash value in addition. Loans or withdrawals reduce what they receive.
Next step
Eric can walk you through a whole life illustration line by line, starting with the guaranteed values. Learn more about life insurance with Eric Henry, Insurance Agent, or start with our term vs. whole life guide.
Coverage descriptions are general information only; your policy documents determine actual coverage. Availability varies by carrier.
