Every life insurance policy has a face value. Also known as the death benefit, the face value is the amount that the insurance company pays out to your beneficiaries when you die.
Cash value life insurance policies add a second feature. With these policies, a portion of each premium payment goes into a separate account, where it accrues tax-deferred interest. The balance of this account is the cash value. Cash value is only available with permanent life insurance policies, whereas term life insurance provides a face value only.
How Your Policy Earns Cash Value Over Time
A portion of every premium payment goes into your policy’s cash value account. From there, how your cash value grows depends on the type of insurance policy you have.
Some policies have a fixed interest rate, which ensures the cash value grows at a steady pace. With other policies, its growth depends on the performance of investment options and market conditions.
When cash value growth is linked to market performance, there is typically a minimum rate of return, called a floor, which protects the cash value from significant declines. However, the policy likely also has a ceiling, putting a cap on the cash value’s annual growth.
Cash Value Life Insurance as an Investment
The cash value of a permanent life insurance policy can function as a tax-deferred savings or investment account. The potential returns and level of risk vary depending on the type of policy you choose.
With whole or universal life insurance, the insurance company will invest the cash value. A whole life insurance policy guarantees a fixed interest rate, insulating your cash value from financial market fluctuations. A universal policy does not provide that insulation but still guarantees a minimum rate of return and offers adjustable policy premiums.
Other policies, such as variable life insurance, allow you to choose where you invest your cash value. The cash value of a variable policy could build much more quickly than that of a whole life policy, but it could also lose value if your investments perform poorly.
Two other options are variable universal life insurance and indexed universal life insurance. The latter is less risky because the cash value is tied to an index, with the insurance company setting both a minimum and maximum rate of return. The former combines the high-risk/high-reward model of variable life insurance with the flexible premiums of universal life insurance.
