Most people think life insurance has one job:
You die, and the insurance company pays money to your beneficiary.
That is certainly one of its most important purposes.
But some types of life insurance can do more than provide a death benefit.
Certain permanent life insurance policies can also build cash value that you may be able to access while you are still living.
That cash value can become a source of financial flexibility for emergencies, business opportunities, major purchases, retirement income or other needs.
And one feature often surprises people:
When you borrow against available cash value in a life insurance policy, you do not have to qualify for the loan the way you would when borrowing from a bank or against the equity in your home.
There is no new credit check, income verification or home appraisal.
That does not mean cash value life insurance is right for everyone. It also does not mean policy loans are free or without consequences.
But it does make this type of life insurance worth understanding and deciding if the benefits of cash value life insurance outweigh any drawbacks.
Let’s walk through it in plain English.
What Is Cash Value Life Insurance?
Cash value life insurance is a type of permanent life insurance.
Unlike term life insurance, which generally covers you for a set number of years, permanent life insurance is designed to stay in force for your lifetime as long as the policy requirements are met.
Certain permanent policies also contain a cash-value or savings component.
Part of the money going into the policy helps cover the cost of insurance and other policy expenses. Another portion may help build cash value over time.
Depending on the type of policy, that cash value may grow based on:
- A guaranteed interest rate
- Dividends
- Current interest rates
- An index-linked crediting method
- Other features of the insurance contract
The important point is that you are building value inside your life insurance policy.
You can learn more about the different options on our cash value life insurance in Phoenix, Arizona page.
What Types of Life Insurance Build Cash Value?
Term life insurance does not build cash value. There is no ability to borrow from the policy and if premiums stop there is no cash value to keep the policy from lapsing.
Cash value is usually found in permanent life insurance policies.
Whole Life Insurance
Whole life insurance generally provides permanent death-benefit protection along with guaranteed cash-value provisions.
Premiums are often designed to remain level, and some policies may also pay dividends. Dividends are not guaranteed although some insurance companies have been paying dividends for generations upon generations.
Universal Life Insurance
Universal life insurance can provide more flexibility in premiums and death benefits than traditional whole life insurance.
How the cash value grows depends on the type of universal life policy.
Indexed Universal Life Insurance
Indexed universal life insurance, often called IUL, is a type of universal life insurance.
Interest credited to the cash value may be based partly on the performance of a market index, such as the S&P 500, subject to the policy’s caps, participation rates, spreads and other terms.
Your money is not directly invested in the stock market.
That difference is important. This is why if the market declines your accumulated cash value doesn’t necessarily follow.
Different policies work differently, so choosing a cash-value policy should begin with your goals rather than simply choosing a product because it sounds attractive.
If you are still comparing permanent coverage with temporary coverage, our term life insurance in Phoenix, Arizona page can help explain the differences.
How Does Cash Value Grow?
Cash value usually builds gradually.
It is not like a bank savings account where every dollar you deposit immediately becomes available to withdraw.
In the early years of many permanent life insurance policies, part of the premium goes toward insurance costs, expenses and other charges.
Over time, a properly funded policy may build meaningful cash value.
How quickly that happens depends on things such as:
- The type of policy
- Your premium
- Your age
- Your health
- The amount of life insurance
- Policy expenses
- Interest or dividend performance
- How the policy was designed
This is one reason policy design matters so much.
Two people could own the same general type of life insurance but have very different results depending on how their policies were structured and funded.
How Can You Access Cash Value?
There are generally several ways to access money from a cash-value life insurance policy.
Policy Loans
Many policies allow you to borrow against the available cash value.
The insurance company lends you the money, using the policy value as collateral.
Interest is charged on the loan.
Withdrawals
Some policies allow you to withdraw part of the available cash value.
A withdrawal is different from a loan and may permanently reduce the policy’s cash value and death benefit.
Surrendering the Policy
You may also surrender, or cancel, the policy and receive its available cash surrender value.
Doing so ends the life insurance coverage and may create tax consequences if the amount received exceeds your tax basis in the policy.
For most people using life insurance as a long-term financial strategy, surrendering the policy is very different from simply accessing part of the available value and the least preferred option.
One Major Benefit: Access Without Applying for a Traditional Loan
This is one of the features of cash value life insurance that many people do not realize.
Suppose you own a home worth $500,000 and you have $250,000 of equity.
That equity belongs to you.
But if you want to use it, you generally cannot simply call the mortgage company and say:
“I’d like $50,000 of my equity, please.”
You usually have to qualify for a home-equity loan or home-equity line of credit.
The lender may look at:
- Your credit score
- Your income
- Your employment
- Your debt-to-income ratio
- Your home’s value
- The amount you owe on the home
You may also need an appraisal, loan documents and lender approval.
If your financial situation has changed, access is not necessarily guaranteed.
Now compare that with available cash value inside many life insurance policies.
When you take a policy loan, you are not applying to a bank for credit.
The insurance company already has an asset securing the loan: your policy’s cash value.
As long as sufficient cash value is available and the policy allows it, you can generally request a loan according to the contract terms.
That means:
No new credit check.
No income verification.
No employment verification.
No debt-to-income calculation.
No home appraisal.
And generally no need to explain why you want the money.
That can provide a type of financial flexibility that is very different from traditional borrowing and very much appreciated for policy owners.
Think About What Could Happen During Retirement
This can become especially meaningful later in life.
Imagine a retired couple who has substantial equity in their home.
On paper, they may look wealthy.
But the house itself does not pay the electric bill, buy groceries or cover an unexpected major expense.
If they suddenly need $30,000, they may consider accessing home equity.
But what if one spouse has died?
What if household income has fallen?
What if they no longer have earned income?
What if credit has changed?
They may still have significant home equity, but getting a traditional loan may depend on satisfying the lender’s requirements.
Available cash value inside a life insurance policy works differently.
Access to a policy loan generally depends on the policy having enough cash value, not whether you still have a job or can satisfy a bank’s underwriting rules.
For some people, that can become an important source of flexibility in retirement.
If retirement income is one of your goals, you can also learn more about retirement income planning in Phoenix, Arizona.
What Can Cash Value Be Used For?
There is not a rule requiring you to use a policy loan for one specific purpose.
People may access cash value for many reasons.
Emergencies
Life does not always cooperate with our financial plans.
A major home repair, unexpected family need or another large expense may arise.
Major Purchases
Cash value may be available for a vehicle, home improvement or another major purchase.
College Costs
Some families may use available cash value as one potential source for education expenses.
Retirement Income
Properly designed permanent life insurance may also provide tax advantaged access to cash value during retirement.
This can potentially provide another financial resource alongside Social Security, pensions, IRAs, investments and other retirement assets.
Business Opportunities
For business owners, access to cash can sometimes matter just as much as the amount of cash available.
A good opportunity may come up unexpectedly.
Maybe you have a chance to:
- Buy equipment at a discount
- Purchase additional inventory
- Expand into a second location
- Hire someone who could help the business grow
- Remodel a workspace
- Buy out a competitor
The challenge is that traditional business financing can take time.
A bank may want to review:
- Business tax returns
- Personal tax returns
- Credit history
- Revenue
- Existing debts
- Cash flow
- Collateral
- Your reason for borrowing
Even a strong business owner may not want to go through that process every time an opportunity comes along.
If you own a properly funded cash value life insurance policy and enough cash value has accumulated, a policy loan may provide another source of funds. For most insurance companies, the time from request to that money in your bank is a matter of days, not several weeks or months.
Unlike a traditional business loan, you do not have to qualify based on your current business income, credit score or debt-to-income ratio.
The life insurance policy itself provides the collateral.
Also, how much and when or even IF you pay back the loan is up to you. For a business owners that is another potential benefit of having your own funding source inside your life insurance policy.
A Simple Business Example
Imagine a small business owner has built $100,000 of available cash value inside a permanent life insurance policy over a number of years.
A neighboring business is closing and offers to sell a piece of specialized equipment for $35,000.
The owner knows the equipment could allow the company to take on more work and increase revenue.
The problem is timing.
The seller wants to close the deal quickly.
The business owner could apply for a traditional business loan.
But that could mean completing an application, providing tax returns and financial statements, waiting for underwriting and possibly being asked for additional collateral.
If the owner’s life insurance policy was structured properly, he or she may instead be able to request a policy loan against the available cash value.
There is generally:
No new credit check.
No business-income qualification.
No business appraisal.
No need to convince a loan officer that the purchase is a good idea.
The owner can then decide whether using the policy loan makes sense based on the loan interest rate, the expected benefit of the equipment and the effect the loan could have on the life insurance policy.
That flexibility may be particularly helpful when an opportunity has a short window.
For business owners, this is one reason permanent life insurance can sometimes serve more than one purpose.
It can provide protection for the owner’s family and the business while also creating a potential source of accessible capital.
You can learn more about protecting a company and the people who make it successful on our Business Owner Insurance in Phoenix, Arizona page.
Cash Value Is Not Free Business Financing
A policy loan is still a loan.
Interest is charged.
If the loan is not repaid, the outstanding balance and accumulated interest will likely reduce the policy’s cash value and death benefit.
Large loans can also increase the risk of policy lapse if they are not managed carefully.
So the question should not simply be:
“Can I borrow from my policy?”
A better question is:
“Does using this policy loan make sense for this particular opportunity?”
That depends on the cost of the loan, the strength of the opportunity, the amount of cash value available and the effect on the policy.
Is a Policy Loan Free Money?
No.
This is important enough to repeat.
A policy loan is still a loan.
The insurance company charges interest.
If you borrow money and do not repay it, the outstanding loan balance and interest may reduce the amount eventually paid to your beneficiaries.
Large loans may also affect policy performance.
And if a policy with a significant outstanding loan lapses, there can potentially be serious tax consequences.
So while accessing a policy loan may be easier than qualifying for a bank loan, that does not mean the money should be borrowed carelessly.
The policy needs to be monitored.
Do You Have to Pay Back a Life Insurance Policy Loan?
Life insurance policies do not require you to repay a policy loan on the same schedule as a traditional bank loan.
There may not be a required monthly principal-and-interest payment like you have with a mortgage or car loan.
That creates flexibility.
But flexibility does not mean the consequences disappear.
Interest continues to accrue according to the contract.
If the loan is not repaid during your lifetime, the outstanding balance reduces what remains in the policy, including the death benefit available to your beneficiaries.
That is why policy loans should be part of a strategy, not treated like an unlimited ATM.
Cash Value vs. Home Equity
The comparison between home equity and cash value can be useful because both represent value you have built over time.
But they work very differently.
Home Equity
Your equity is the difference between your home’s value and the debt against it.
To turn that equity into spendable cash, you may need to:
- Sell the home
- Refinance
- Obtain a home-equity loan
- Open a HELOC
- Use another lending arrangement
A lender usually determines whether you qualify.
Life Insurance Cash Value
Cash value exists inside the policy.
Depending on the contract, you may be able to access it through a loan or withdrawal, usually both options.
With a policy loan, there is not a traditional lender underwriting process because the policy provides the collateral.
That can make cash value a more accessible source of funds when traditional credit is difficult or inconvenient.
However, unlike home equity, cash value is part of a life insurance contract with policy expenses, loan interest and other provisions.
Neither is automatically better.
They are simply different financial assets with different strengths and limitations.
Can Cash Value Life Insurance Provide Tax Advantages?
Cash value life insurance can have several potential tax features.
Tax-Deferred Growth
Generally, cash value grows inside the policy without annual income taxation on that growth.
Policy Loans
Policy loans are generally not treated as taxable income when taken from a properly structured and maintained life insurance policy.
Death Benefit
Life insurance death benefits are generally received by beneficiaries free from federal income tax, although individual circumstances and estate-tax considerations may differ.
However, tax treatment can change if a policy becomes a Modified Endowment Contract, is surrendered with gains or lapses with outstanding loans.
Tax laws are complicated, so you should work with a qualified tax professional for advice about your individual situation.
Cash Value Life Insurance and Retirement Planning
Cash value life insurance is sometimes used as part of a broader retirement strategy.
That does not mean you should stop contributing to your 401(k) or IRA and put everything into life insurance.
Different financial tools have different jobs.
A 401(k) may provide employer matching and tax advantages during one’s working years.
Investments may offer greater long-term growth potential.
Savings can provide liquidity.
Life insurance provides a death benefit, and certain policies may also create accessible cash value.
For some people, having money in different types of financial accounts may create additional flexibility.
If predictable retirement income is also part of your goal, our guide to fixed indexed annuities and retirement income in Arizona explains another approach retirees sometimes use.
What About Living Benefits?
Cash value and living benefits are not the same thing.
Cash value is money accumulated inside certain permanent life insurance policies.
Living-benefit riders may allow an insured person to access part of the policy’s death benefit after experiencing a qualifying chronic, critical or terminal illness.
Some permanent life insurance policies may offer both.
That means a policy could potentially provide:
- A death benefit for your family
- Cash value you may access during life
- Living benefits for certain qualifying illnesses
Exact benefits vary by carrier and contract.
Our guide to living benefits in life insurance explains this feature in more detail.
What Are the Downsides of Cash Value Life Insurance?
Cash value life insurance has benefits, but it is not appropriate for everyone.
It Usually Costs More Than Term Insurance
Permanent life insurance generally requires higher premiums than comparable term coverage.
It Is a Long-Term Strategy
Cash value usually takes time to build.
It is generally not designed for money you expect to need in the near future.
Policies Can Be Complex
Some products have guarantees.
Others include interest-crediting formulas, flexible premiums or non-guaranteed elements.
You should understand what you are buying.
Loans Can Affect the Policy
Excessive borrowing may reduce cash value, reduce the death benefit and increase the chance that a policy could lapse.
Poor Policy Design Can Produce Poor Results
Cash value life insurance is not just about choosing a company.
How much insurance is purchased, how premiums are funded and how the policy is structured all matter. Working with an experienced and independent life insurance professional for guidance is highly recommended.
Who Might Consider Cash Value Life Insurance?
Cash value life insurance may be worth exploring for someone who:
- Wants permanent life insurance
- Wants to leave a financial legacy
- Wants another long-term source of accessible funds
- Has sufficient cash flow to properly fund the policy
- Values tax diversification
- Wants additional financial flexibility in retirement
- Likes the idea of building an asset that may be accessed without traditional loan qualification
- Also, someone who owns a business
It may not make sense for someone who mainly needs inexpensive temporary coverage or who would struggle to maintain the required premium.
For those situations, term life insurance may be more appropriate.
Questions to Ask Before Buying Cash Value Life Insurance
Before purchasing a policy, ask:
How soon will meaningful cash value be available?
What values are guaranteed and what values are not?
How much flexibility is there concerning premium contributions?
How is interest or growth credited?
What interest rate applies to policy loans?
What happens to my death benefit when I take a loan?
What happens if I do not repay the loan?
Could the policy lapse if I borrow too much?
How does the policy perform under more conservative assumptions?
And perhaps most importantly:
Why am I buying this policy?
Life insurance should solve a real financial need.
Cash Value Life Insurance in Arizona
For families, professionals, retirees and business owners in Surprise, Phoenix, Peoria, Glendale, Goodyear, Buckeye, Sun City and throughout Arizona’s West Valley, cash value life insurance can serve more than one purpose.
It can protect your family if something happens to you.
It can build value while you are living.
And if properly structured and funded, that value may provide another source of financial flexibility later.
The ability to access available policy cash value without going through the traditional bank loan qualification process is one feature that makes permanent life insurance different from many other assets.
But the goal should never be simply to buy a policy because it has cash value.
The goal is to determine whether the policy fits your life, your family, your business and your long-term financial goals.
At Kratos Financial & Insurance Solutions, Bonnie Clark helps individuals, families and business owners understand life insurance choices in plain English.
If you are wondering whether cash value life insurance in Phoenix, Arizona may fit into your protection, retirement, business or legacy strategy, the first step is simply understanding how the numbers and features work for you.