What is Cash Value Life Insurance?

Many permanent life insurance policies include a savings component, called cash value. This cash value account earns interest — at a fixed or variable rate — and grows on a tax-deferred basis. In the beginning, a large part of your premium payments goes towards insurance costs and fees, resulting in slow cash value accumulation.

Cash value of a life insurance policy is meant for you, the insured. This is in complete contrast to the death benefit, which is meant for your beneficiary.

How does cash value life insurance work?

The term cash value is called as such since you can take a loan against or withdraw money from the life insurance policy’s cash value and use the funds however you like, while you're still alive. If you die and there is some cash value remaining in the policy, the life insurance cash will go back to the insurer. Your beneficiary will not receive the life insurance cash value upon your death, but only the policy amount.

The premium of a cash value life insurance policy is used for three things:

• funding the policy's death benefit and covering the cost of insuring your life
• paying policy fees and other charges
• fund the cash value account

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Different types of permanent life insurance policies

Cash value is usually available in a permanent life insurance policy. A permanent life insurance policy has different types of life insurance which accrue cash value differently but each lets you access it via withdrawal, loan, or surrender.

• Whole Life Insurance - Whole life insurance offers fixed premiums and a guaranteed death benefit while accumulating cash value. Participating policies can grow faster by reinvesting earned dividends.
• Universal Life Insurance – Universal life insurance offers more flexibility than whole life, allowing adjustments to premiums and death benefits within limits. You can also choose investment options, which can lead to higher returns—but with greater risk.

Be advised that term life insurance does not offer the cash value feature or cash surrender value since term life insurance policies are designed to last for a limited period. This doesn't mean that term life is not a type of life insurance you should consider, since it is less expensive and simpler than permanent life insurance.

Life insurance policies that accumulate cash value are more expensive than those that do not. Generally speaking, one can expect to pay six to 10 times more for a cash value life policy.

How Can You Withdraw Cash Value?

Your life insurance policy’s cash value is your money. You can tap into it as needed. However, the options available for accessing it depend on your life insurance policy type and the provider. If you no longer need coverage, don't let your policy lapse since you'll lose the death benefit as well as any cash value you could have received.

Use the cash value to pay the premiums

Certain universal life policies allow you to pay monthly premiums with the policy’s cash value. Using this strategy when you’ve accumulated cash value or your policy has a low interest rate might not be a great idea. If the cash value drops too far, you risk losing coverage.

For instance, let’s say you have a cash value of $10,000, while the annual premium for your life insurance policy is $5,000. If the cash value grows at a rate of 2.5% per year — which is a reasonable estimate — you can use the interest to pay half of your premiums.

Whole life policies, by contrast, usually do not let you use the policy's cash value to pay premiums. To be able to do that, you will need to convert it into a paid-up policy, but with paid-up whole life insurance policies, every premium payment is subtracted from the policy's death benefit. Also, this option is not available with all insurers and comes into play only if your cash value is sufficiently large.

Borrow a loan against it

A policy loan is another way to tap the cash value. You can use the loan amount from your life insurance any way you like as long as your cash value is sufficient. Your insurer will not run a credit check for approval, nor are there any underwriting requirements. 

Since you are borrowing your own money, you can choose not to repay the loan, and you will not have to pay taxes on the loan. However, this will lower your cash surrender value since the amount you borrow, plus interest, will be deducted from the death benefit your family receives.

Borrowing against your policy's cash value generally comes with low annual interest rates. Whatever interest amount you do not pay gets automatically added to the outstanding loan balance. For this reason, you need to closely monitor the outstanding loan amount as this will reduce the cash surrender value. If it exceeds your policy’s cash value, you will lose coverage. Furthermore, the loan will likely attract income tax payments.

Sell your life insurance policy

Selling your life insurance policy to a third party — usually an insurance company — is called a life settlement. You may find this option attractive if you no longer want to pay premiums and your dependents have become financially secure.

Note that in Canada, you are unable to sell your life insurance policy in most provinces.

Surrender the policy for its net cash value

A life settlement is more profitable than surrendering the policy. But if you cannot find a buyer and want to cash out the policy, consider surrendering it.

Surrendering a life policy is the same as canceling it (thus giving up the death benefit). The insurer will deduct the surrender charges, outstanding loan balance, and other fees from your cash value and pay the remaining amount. That is, you will receive the net cash value (actual cash value – surrender charges and other fees). And your coverage will cease to exist. Lastly, when you surrender the policy, it's possible that you'll be required to pay income tax on the amount you receive.

As you may guess, the net cash value is always lower than the actual cash value. However, the longer you hold on to your life insurance policy, the lesser the difference between the two. If you have had the policy for 12-15 years, you are likely to receive an amount that is close or equivalent to the actual cash value.

Make a partial withdrawal

If you are low on funds or want to make a large purchase, a partial withdrawal may be a good option. You can also consider this option if you need less protection than before. For example, your children are now financially independent, and you need coverage only for your spouse or partner.

With universal policies, each withdrawal reduces the death benefit amount on a dollar-for-dollar basis. However, some whole life policies reduce the life insurance payout by an amount greater than what is withdrawn. So, before you withdraw cash value, check how it will affect the death benefit. You also may need to pay income tax on the amount you withdraw. The tax depends on how much you take out compared to your policy's cash value.

Increase your death benefit

Depending on your policy and insurer, you may be able to use the policy's cash value to buy more life insurance. This way you can ensure the cash value that you have built over the years does not go into your provider’s pocket upon your death.

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Benefits of cash value life insurance

Includes a forced savings vehicle

A cash value life insurance policy has a built-in savings component. Whether you like it or not, a part of your premium payments is funneled into this account. If you keep your policy active for long enough, eventually you will get more than what you had invested.

David, a 45-year-old business owner, struggled with saving money, often reinvesting in his business instead. HTo build financial discipline, he took out a whole life insurance policy with a cash value component, which forced him to save as part of his premium payments. Over 20 years, his policy accumulated significant cash value, surpassing his contributions. He later used these funds to supplement his retirement while keeping his life insurance protection intact.

Serves as an additional investment vehicle

Life insurance is mainly a financial tool for securing the future of your loved ones. The payout can help them to live comfortably after you are gone. However, cash value life insurance also serves as an investment vehicle.

If you are a high-net-worth individual and have exhausted traditional investment vehicles, a cash value policy can help you create a financial safety net for your family and grow your wealth on a tax-deferred basis.  

Sarah, a high-net-worth investor, had maxed out her RRSP and TFSA but wanted a tax-efficient way to grow her wealth. She purchased a cash value life insurance policy, which accumulated tax-deferred savings while ensuring a guaranteed death benefit. Over time, the policy became a stable, low-risk asset, providing liquidity and enhancing her estate plan, giving her family long-term financial security.

You can use the cash value in different ways

Cash value may be used to buy additional coverage or pay premiums. You can withdraw from or borrow against the cash value and use the money as you like. If you no longer need coverage, you can surrender the policy for its net cash value.

Mark, a 55-year-old policyholder, had built significant cash value in his whole life insurance policy over the years. When his income fluctuated, he used the accumulated cash value to cover premium payments instead of out-of-pocket expenses. Later, he borrowed against the policy to fund a business investment. Eventually, when he no longer needed coverage, he surrendered the policy and accessed the net cash value as a lump sum, giving him financial flexibility when he needed it most.

Drawbacks of cash value life insurance

As useful as cash value life insurance is, it comes with its own set of disadvantages.

Lower return than traditional investment vehicles

A cash value life insurance policy gives you a lower return than most traditional investment vehicles (if not all). To make matters worse, these policies have much higher fees than other investment vehicles.

Expensive

Cash value life insurance is many times more expensive than term life insurance. It is also considerably more expensive than a permanent life insurance policy without a savings component.

Is Cash Value Life Insurance Right for You?

Cash value life insurance could make sense for people who want a life insurance policy and an investment component rolled into one. There are different types of cash value life insurance policies, the most common being universal life and whole life insurance.

Permanent life insurance policies are simpler to understand and maintain than universal life insurance. They have guaranteed death benefit, monthly premiums, and rate of return on cash value.

In 2023, Canadian whole life insurance reached a record high, with new annualized premiums increasing by 10% to $1.27 billion. This growth was primarily driven by participating whole life products, which offer policyholders dividends that can be used for additional coverage or cash value growth. These products accounted for 88% of the whole life market and saw a 12% increase in premiums. Overall, whole life insurance represented 68% of the Canadian life insurance market in 2023. 

Universal life insurance, on the other hand, offers more flexibility. Some universal life insurance policies let you adjust your premiums and the policy amount. You can also pick investment options that perfectly match your risk tolerance and long-term goals. These policies, however, carry greater risk than whole life insurance.

Cash value life insurance provides coverage for your entire lifetime and accumulates wealth. It can be used to add to your retirement income, pay for medical expenses, or meet other financial needs. It can be a great option for certain people. For example, if you are someone who has already maxed out traditional investment vehicles, such a policy may suit you better than term life insurance.

However, cash value life insurance is more complicated. Before purchasing life insurance, it is always a good idea to consult an experienced life insurance broker, like Dundas Life, to understand all available options such as term or whole life insurance.

Frequently Asked Questions

Do all life insurance policies have a cash value?

No, not every life insurance policies have a cash value. Permanent life insurance products, such as whole life and universal life insurance, generally include cash value. Term life insurance, which only lasts for a specific period, do not offer a cash value feature.

Which life insurance has cash value?

Permanent life insurance policies have a cash value component. Whole life insurance, universal life insurance, and some assured issue life insurance plans are examples of these. Each of these policies builds cash value in different ways and allows you to access it through a withdrawal, loan, or surrender.

What happens to cash value in a whole life insurance policy at death?

Upon the death, any remaining cash value in a whole life insurance policy goes back to the life insurance company. The beneficiary, however, does not receive the cash value. They only receive the policy's death benefit. However, the cash value can be used during the policyholder's lifetime in various ways, such as taking a loan against it or using it to pay premiums.