Whole life insurance policies have a unique feature that makes them ideal vehicles for growing and protecting wealth—cash value. But how does cash value life insurance work? How does it grow? How do you go about cashing out life insurance? How do you access your money and what are the tax implications? Let’s break it down.
What is the Cash Value of Whole Life Insurance?
What makes the cash value of your whole life policy so beneficial?
Cash value life insurance can function as your emergency savings. a Cash value policy is your ideal volatility buffer for uncertain economic times and financial emergencies.
Cash value life insurance creates the basis of your financial foundation. By offering both living benefits and death benefits, whole life insurance and the cash value in offer financial security.
Cash value life insurance is free from market volatility and the risk associated with stock investments. Whole life insurance is backed by mutually funded insurance companies, not Wall Street, and offers guarantees not found with other investment vehicles.
Cash value life insurance earns a better rate of return than a savings account, money market, or CD. The average rate of return varies by carrier, but it is guaranteed and you’ll likely earn dividends on top of interest earned.
Cash value life insurance frees up money for other investments while continuing to grow inside a whole life insurance policy. Even when you take out a policy loan, you still earn interest on the entire cash value of your policy.
Cash value life insurance allows you to become your own bank. The cash value in your life insurance coverage and policy is yours to use, free of creditors and traditional financial institutions.
The cash value portion of whole life insurance, by definition (it’s actually called the cash surrender value), is the contractual dollar amount the insurance company will exchange with a policy owner in the event the insurance policy is surrendered, or cancelled. However, unless you stop paying your full premium payments, it’s highly unlikely your policy will be surrendered. So what do you do with your cash value?
How to Use Cash Value of Whole Life Insurance
The most common use of cash value component in a whole life insurance policy is a policy loan. Policy loans have unique advantages compared to traditional loans from banks or creditors. They carry less risk and put the policyholder in control.
The Life Insurance Policy Loan
Through the policy loan provision, a policy holder can access their cash value account without incurring taxes. This is because policy loans are treated as debt, which is not a taxable distribution. The same cannot be said for wealth tied up in other investments, like a 401(k) or IRA, where you are taxed for accessing your money and even charged a penalty if you use it before age 59 1/2. Think of a policy loan more like a real estate cash-out refinance. No taxes are paid on the refinance proceeds.
When you take out a policy loan, there is no lengthy application or approval process. The cash value of whole life insurance is the basis by which the insurance company will loan to the policy owner. The life insurance company will not lend the policy owner more than the total cash value of the policy owner’s life insurance policy.
You can consult with your financial advisor or a Wealth Strategist for recommendations on when to take out a loan and for how much, but ultimately your cash value is there to use when you need it. You don’t need to put up assets like your home or business for collateral; the collateral is the insurance policy itself.
Although policy loans are not required to be paid back, it is recommended. The insurance company charges interest on the outstanding policy loan but does not require payments to be made. However, an outstanding policy loan will reduce the overall available cash value and if death were to occur with an outstanding policy loan, the loan would be paid back via the policy’s death benefit proceeds.
You can use a policy loan to fund anything from mortgage loans to college tuition, unexpected medical costs, and more. It can take the place of your emergency fund, or be used to take advantage of investment opportunities where the policy loan offers a more favorable interest rate.
The policy loan feature isn’t just for personal use either. Many companies purchase whole life insurance as assets and use policy loans to fund business costs. In fact, big-name companies like McDonald’s, Disney, and Pampered Chef survived because of the cash value of whole life insurance.
It’s even possible to use the cash value of your whole life insurance policy to pay your policy premium. There are a few ways to accomplish this.
Paying Premiums With Whole Life Insurance Cash Value
- Structure a policy for maximum cash value growth with a Paid-Up Additions rider. This speeds up the rate at which your policy is “paid-up” and life insurance premiums are no longer required.
- Use a policy loan to pay premiums. This is a good option for those experiencing temporary financial hardship, and can minimize your life insurance costs in the short term.
- Withdraw a portion of your cash value to pay your premium. If you don’t foresee being able to pay back a policy loan and you don’t want an outstanding loan to negatively impact the death benefit of your whole life policy, this may be the right choice. Keep in mind you may be subject to taxes, dependent upon the amount you withdraw.
- Use dividends to pay your premium. If you’ve had a whole life insurance policy for quite awhile, you may have earned enough dividends over time to pay life insurance premiums without additional capital investment.
Cash Value Life Insurance Withdrawal
The cash value of whole life insurance is also accessible by the policy owner through a partial surrender, which is a physical withdrawal of the policy’s cash value. As mentioned, when you withdraw money, a portion of your cash value to pay your insurance premium, you may be subject to taxes, depending on the amount you withdraw.
The use of cash value is seen most often in policyholders who are in or nearing retirement. Cash value is used to supplement or replace retirement income from a 401(k) or IRA. Cash value can also be used in estate planning. It offers a good way to distribute wealth onto the next generation, particularly if certain hard assets—land, property, real estate—are difficult to divvy up.
Unlike other assets or investments, the cash value in whole life insurance is 100% liquid. The money is there when you need it, regardless of whether or not you decide to take out a policy loan or make a withdrawal. The same cannot be said of funds in a 401(k) or IRA, stock market, or real estate investment.
How to Grow Cash Value in Whole Life Insurance
Now you know the myriad ways cash value in a whole life insurance policy can be used. But how do you grow it? How do you increase your cash value for bigger policy loans or greater retirement income?
Cash Value: Premiums, Interest & Dividends
Premiums
When you pay your life insurance premium, a portion of the premiums paid goes toward covering the cost of your death benefit. The other part of it goes toward the cash value of your insurance policy. This is why it’s so important to have properly structured whole life insurance that’s in line with your financial goals and needs.
If your main reason for buying life insurance is to have a guaranteed death benefit, the cash value of your policy may be secondary to the amount of your death benefit. There are plenty of agents, brokers, and insurance companies that can accommodate structuring whole life for this purpose.
But if your main goal is to enjoy the living benefits of your whole life insurance policy—cash value withdrawal, tax advantages, retirement income, policy loans—it must be structured specifically to grow cash value. Traditional whole life insurance policies won’t provide enough of a return to enjoy these benefits. One of the best ways to grow the cash value of your insurance policy is with a Paid-Up Additions rider.
Interest
Whole life insurance is a unilateral contract between the insurance company and the policy owner. In this contract there are guarantees and benefits to the policy holder(s), one of which is guaranteed cash value growth. Your policy is guaranteed to earn interest over time. While the amount of interest varies by carrier, many permanent life insurance policies earn an average 5% annually. The interest earned is tax free, which makes it even more lucrative.
Dividends
When you’re insured with a mutual insurance company, you have ownership in the company the same way members of a credit union have ownership of the credit union. This ownership entitles you to a portion of the company profits paid out in the form of dividends. Dividends are declared every year by the mutual insurance company who issued the policy. In the subsequent year, they are divided amongst policy owners on the anniversary date of their policy. The anniversary date is the month and day the policy was originated.
Although dividends are not guaranteed, mutual insurance companies have a long track record of paying dividends. Some companies have paid for over 200 years, even amid wars, pandemics, and significant market downturns like the Great Depression.
Mutual insurance companies are able to remain solvent because they hedge their economic risk among a variety of insurance products, including annuities, whole life insurance, universal life insurance, and term life insurance, to name a few. Each of these products carries its own set of benefits and risks, which off-set the cost of paying out the death benefit and make insurance companies profitable enough to pay dividends to whole life insurance policyholders.
You can use your dividends to buy Paid-Up Additions riders and increase the cash value of your policy faster, and Paid-Up Addition riders themselves also earn dividends.
Tax Advantages for Cash Value in Whole Life
The cash value in your whole life insurance policy is privy to various tax advantages you won’t find with other investment vehicles like CDs and IRAs, which generally only defer taxation. The way your whole life insurance policy is structured will have an effect on how it is taxed.
In the previous section about premiums, you learned that opting for a whole life insurance policy structured specifically for cash value may include using a Paid-Up Additions rider. This helps you grow your cash value faster, but if you grow cash value in an insurance policy too fast, you could get penalized by the IRS.
For maximum tax advantages on the cash value of your policy, you need to make sure your policy doesn’t become a Modified Endowment Contract, or MEC. Essentially, this means the IRS has deemed your cash value is too high in relation to the death benefit of your policy. If this happens, you won’t be able to use the growth of your cash value tax free. In other words, policy loans may be taxed. To avoid this scenario, speak with a Wealth Strategist to make sure your policy is structured for maximum tax advantages and maximum allowed growth.
There are two ways accumulated cash value can be used without paying taxes.
First, when the cash value is withdrawn for income or otherwise, it is tax free until the withdrawals exceed the basis of the policy. The basis is the amount of premiums that have been paid over time by the policy owner. At this point the withdrawals are taxed at ordinary income tax rates.
Second, as previously mentioned, policy loans aren’t taxed. You can borrow your money tax free and penalty free.
For more information on the tax benefits of a whole life insurance policy and its cash value, listen to this episode of The Perpetual Wealth Podcast with Paradigm Life CEO Patrick Donohoe.
Summary: Cash Value & Whole Life
Whole life insurance is a unique financial product because of the guarantees, tax benefits, and historical positive performance. The cash value inside a whole life policy offers a unique source of cash flow and increased revenue to help you accomplish your financial goals and enjoy financial freedom. Life Insurance for business owners is provides businesses with unique tax benefits as well.
For more information on the cash value of whole life insurance, cashing in a life insurance policy, and how it can play a part in your financial situation, 
with a Paradigm Life Wealth Strategist. We’re here to answer all your questions, no strings attached.
To learn more about Infinite Banking and the guaranteed benefits found within whole life insurance download our free article.
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