What is cash value life insurance & how does it work?

Life insurance can help provide financial protection for the people you care about. Some types of life insurance also build cash value you may be able to access during your lifetime for a range of financial needs.

Learn how cash value life insurance works, how it differs from term life insurance and what benefits it may offer.

Cash value life insurance (CVLI) is a type of permanent life insurance that includes two components: a death benefit and cash value.

The death benefit is a lump sum generally paid tax-free to your beneficiaries when you die. The cash value can grow over time while the policy remains in force. Unlike term life insurance, which typically provides coverage for a set period of 10 to 30 years, cash value life insurance is designed to provide lifelong coverage.

Here’s how it works: A portion of each premium payment covers the cost of insurance and insurer expenses, a second portion supports the death benefit, and the remaining amount is deposited into the cash value account. Depending on the type of policy, the cash value may grow at a fixed rate, earn interest or be tied to investment performance.

• Cash value: The amount accumulated in your policy's savings account
• Cash surrender value: The amount you would actually receive if you canceled today (cash value minus surrender charges and outstanding loans)

If you need access to the cash value portion of your policy, you may be able to make a withdrawal or take out a loan against it, depending on the policy. Whether that money is for something like your child’s college education or an emergency repair, keep in mind that unpaid loans and withdrawals can reduce both the cash value of your policy and the death benefit available to your beneficiaries.

Four common types of permanent life insurance that build cash value are whole life, universal life, variable universal life and indexed universal life. Each life insurance policy type provides a tax-advantaged death benefit and accumulates cash value in a different way.

Whole life insurance is the most common type of cash value life insurance. It offers a death benefit and cash value that grows at a guaranteed rate. With traditional whole life, premiums are guaranteed throughout the life of the policy, and some policies also may pay dividends or allow you to add riders for additional features and benefits.

Universal life insurance offers more flexibility than whole life insurance. Depending on your policy, you may be able to adjust the amount and timing of your premium payments, and the cash value typically earns a market rate of interest. However, with the added flexibility comes the possibility of higher premiums down the road. This can result from factors like policy performance and the amount credited into the policy.

VUL works similarly to universal life insurance, but it allows you to invest your cash value in subaccounts. This gives your cash value more growth potential, but it also comes with more investment risk. It offers a mix of diversified investment options to choose from and adjustable premium payments.

An IUL is a type of permanent life insurance that combines a death benefit with a cash value account. The cash value grows based on the performance of a market index, such as the S&P 500, although the money is not directly invested in the stock market. Depending on the policy, an IUL may offer some protection against market losses, though limits may apply to how much of the gains you receive of the tracked index.

Each type of cash value life insurance offers a different balance of guarantees, flexibility and growth potential. Reviewing policy illustrations with a financial advisor can help you compare your options.

Term life insurance helps provide simple protection during a set period of time, typically between 10 and 30 years. Cash value life insurance gives you protection throughout your life as long as you provide adequate funding and your contract retains its value. And there are pros and cons for both.

The cash value in a life insurance policy can help support a variety of financial goals you might have over the years. Here are five common examples.

When it's time to pay for tuition, books or housing expenses, you may be able to use your policy's cash value to help offset costs.

Imagine you took out a permanent contract in your 30s and stayed current with premium payments until you retired at age 67. Assuming your cash value increased, you could receive payments from the contract's cash value to supplement your other retirement income.

If you bought a CVLI at a younger age, you may have enough cash value to use it as a down payment on a home purchase. Before you access the cash value, be sure to calculate how much life insurance you may want to retain.

Cash value may be available to help cover unexpected costs, such as emergency home repairs or living expenses if you’re laid off. Unlike a traditional bank loan, borrowing against a life insurance policy's cash value typically does not require a credit check or lengthy application process.

Depending on your policy, available cash value may be used to help cover premium payments. This can be especially helpful if your income changes or after you retire. However, using too much cash value for premiums could reduce policy value and increase the risk of lapse.

If you decide to access the cash value of your policy, it's important to understand how different methods may affect your death benefit, taxes and long-term policy value.

If you're eligible and decide you want to tap into that cash value, you have three options: withdrawals, loans and full surrenders.

Let's say you were 32 years old when you purchased a whole life insurance policy and had a child. Now you're 58, your home is paid off and you're no longer financially responsible for your child.

Many policies allow you to make a tax-free withdrawal up to your cost basis, which is generally the total amount you've paid in premiums, minus previous withdrawals and dividends received.

If you withdraw funds from the cash value account, your death benefit decreases. You’ll also have to pay income tax on any cash distributions that are higher than your cost basis.

Depending on your policy, restoring that value may not be possible. It's also important to remember that beneficiaries generally receive the death benefit, not the policy's cash value. Any remaining cash value typically remains with the insurer.

Basis = Total premiums paid − Prior withdrawals − Dividends received

For example, if you have paid $50,000 in premiums but have taken $8,000 in withdrawals and received $2,000 in dividends, your basis would be $40,000.

Generally, withdrawals are tax-free up to your basis. Any withdrawals above that amount may be treated as taxable income. Policy loans, however, are generally not taxable as long as the policy remains in force.

If you take out a loan from the cash value of your life insurance policy, the death benefit your beneficiaries receive will be reduced by any outstanding loan balance.

As long as the policy remains in force and the terms allow it, you may repay the loan with interest to restore both the death benefit and the policy’s cash value. The amount you can borrow depends primarily on the policy’s current cash value.

If you end or surrender your contract early, you'll be taxed on any money you receive that exceeds what you paid into the policy. Before canceling your life insurance policy, consider the potential tax consequences and the impact of losing your coverage.

The taxability of life insurance

Life insurance contracts have specific features that can help families manage their tax liability.

Explore our life insurance taxability guide

When you die, beneficiaries generally receive the death benefit, not the accumulated cash value. The cash value is generally not added to the death benefit at death because it is already part of the policy's internal value structure during your lifetime.

However, some policies offer a “return of cash value” rider or a death benefit option that increases as cash value grows. With these features, the insurance company may pay both the death benefit and some or all the accumulated cash value to beneficiaries. These options typically come at an additional cost and may reduce how efficiently the policy builds cash value over time.

Because beneficiaries typically receive only the death benefit, some policyholders choose to access a portion of their cash value during their lifetime.

One reason people choose cash value life insurance is its potential tax advantages. Depending on your policy, cash value can grow tax-deferred and may be accessed tax-free up to your cost basis.

Many types of cash value life insurance include interest, dividends or investment options that can help grow your policy's cash value over time. Any growth generally accumulates tax-deferred, meaning you’re not likely to owe taxes on gains until you withdraw them.

Under some policies, you may be able to access cash value through withdrawals, loans or surrenders. Withdrawals are generally tax-free up to your cost basis, while policy loans are generally income-tax-free if the policy remains in force. However, certain situations, such as a policy terminating with outstanding debt, can create a tax liability.

If premium payments exceed IRS limits, the policy may become a modified endowment contract (MEC), which changes the tax treatment of withdrawals and loans. Because MEC rules can be complex, it's important to understand the tradeoffs before contributing additional funds.

Cash value life insurance can provide both lifelong protection and financial flexibility through the cash value it builds over time. The right policy depends on your goals, timeline and how you plan to use those benefits. A Thrivent financial advisor can walk you through a policy illustration and help you decide what fits your short-term and long-term goals.