How does whole life insurance build cash value? It’s a combination of your monthly payments and interest paid by your insurer. Let’s take a look at how whole life insurance can help your family build a more secure financial future.
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Request a Free QuoteWhat Is Cash Value?
Cash value is a component of every type of permanent life insurance. It is not available with term life insurance. When you buy a permanent policy, it covers you for life. As long as you keep making your payments, your coverage will never expire. So no matter when you pass away, you know your loved ones will get a 100% tax-free death benefit. The tax-free death benefit and the non-expiring coverage are two great benefits of whole life insurance.
Cash value is separate from the policy’s death benefit. It’s an account attached to your policy – think of it like a type of savings account.
When you make a payment, the insurer takes that money and uses it for several purposes:
- Pays toward the cost of your coverage (the death benefit for your loved ones).
- Pays administrative costs associated with the policy.
- Adds anything left to your cash value account.
It takes a couple years to really see the growth in your cash value account. But those early years are also your best chance at growing that cash value. That’s because the cost of your coverage increases as you get older.
Let’s say you buy a policy at age 30. Here’s what happens:
- Early years of the policy: There are probably quite a few years before you’ll pass away, so the cost of your coverage is low. More of every payment you make is going into that cash value account.
- Later years of the policy: By the time you reach age 65, for example, it’s getting more likely that the insurer will need to pay out on your behalf, so the cost of your coverage will be more than in previous years. That means less of every payment you make will be deposited into your cash value account.
As you’ll see below, every penny that goes into a cash value account can really grow thanks to the power of compound interest over time.
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Request a Free QuoteSo How Does Whole Life Insurance Build Cash Value?
Whole life policies pay a low but guaranteed rate of interest on your cash value. The rate is fixed, set by your insurer when you buy the policy. With whole life insurance, it’s usually pretty low (a couple percentage points). As of 2023, most average annual rates of return clock in between 1 and 3.5%.
NOTE: Keep in mind that whole life isn’t designed for accumulation, like some other forms of life insurance. If you’re more interested in accumulation and the chance to earn higher interest rates, check out our pages on indexed universal life and variable life.
Over time, the as your whole life cash value account gets bigger, you’ll get more interest paid out. So even though less of your premium payment goes into that account, your interest payments help make up the difference.
Another bonus? Everything in your account grows tax-deferred, so there’s no tax liability to worry about while your account is growing.
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Request a Free QuoteHow Does Compound Interest Work?
Compound interest is what makes even a low interest rate payment pay off big over time. Here are two examples that shows you the power of compounding interest. You can play around with the numbers yourself by using the compound interest calculator at Investor.gov.
Example #1: $100,000 policy
This estimate is for a 30-year-old man, non-smoker, preferred plus health class with a $100/month payment.
- End of year 1: $80/month from his payment goes into the account for 12 months: $800
- End of year 10: $80/month from his payment goes into the account for 12 months each over the next 9 years, at a rate of 2% interest compounded annually: $11,486.93
- End of year 20: $70/month from his payment goes into the account for 12 months each over the next 10 years, at a rate of 2% interest compounded annually: $23,200.35
- End of year 30: $60/month from his payment goes into the account for 12 months each over the next 10 years, at a rate of 2% interest compounded annually: $36,164.47
This hypothetical client is now 60 years old and has $36,164.47 in cash value – not bad!
Example #2: $200,000 policy
This estimate is for a 30-year-old woman, non-smoker, preferred plus health class with a $200/month payment.
- End of year 1: $150/month from her payment goes into the account for 12 months: $1,800
- End of year 10: $150/month from her payment goes into the account for 12 months each over the next 9 years, at a rate of 2% interest compounded annually: $21,903.69
- End of year 20: $130/month from her payment goes into the account for 12 months each over the next 10 years, at a rate of 2% interest compounded annually: $43,782.42
- End of year 30: $110/month from her payment goes into the account for 12 months each over the next 10 years, at a rate of 2% interest compounded annually: $67,823.54
This hypothetical client is now 60 years old and has $67,823.54 in cash value – a nice amount to use to supplement retirement income, renovate the house, or help put a grandchild through college.
➡️ Want to talk to a real person about whole life insurance and cash value? Call us at 800-823-4852! We’d love to help.
Request a Free QuoteHow Can You Access Your Whole Life Policy’s Cash Value?
Depending on how long you live and the rate of interest you get, it’s possible you’ll end up with more cash value than the death benefit. This is money you can and should use during your lifetime. If you don’t, it will go back to the insurance company after you pass away. Cash value that exceeds the policy’s face value is a “use it or lose it” benefit – so it pays to read your policy statements and keep an eye on things!
Here’s how you can access your cash value:
- Loans. Your insurer will loan you money from your cash value, at a lower rate of interest than a typical bank loan. And although it’s set up as a loan, you don’t technically have to finish paying it back. If there is an outstanding loan when you pass away, the insurer will deduct that amount from the total death benefit owed to your loved ones.
- Withdrawals. You can also withdraw your cash value, up to the amount allowed by the insurer, minus any fees they charge for the transfer.
- Surrender value. If you don’t need your policy anymore, you can surrender it and collect its cash value, minus the insurer’s surrender fees. If you choose this option, please be aware that it ends your coverage – there is no longer a death benefit for your beneficiary(ies).
- Use it to make your payments. If you’ve accumulated enough cash value, you can ask your insurer to use it in place of your monthly payments to pay for the cost of your coverage. It’s up to you to keep an eye on the total amount over time to make sure there’s enough to make that payment and that your coverage doesn’t lapse.
You may be wondering…is there tax liability? Only if you pull out more cash value than the sum total of all your premium payments. For example, if you’ve paid $30,000 into your policy and withdraw $30,000, you would owe zero tax on that money. But if you’ve paid that same $30,000 and withdraw $40,000, you would owe income tax on $10,000. Before you withdraw money from your cash value, check with your tax professional first for advice that’s tailored to your situation.
We always tell our clients that the greatest benefit of any whole life policy is the peace of mind that comes from the death benefit. That’s the number one reason to buy any policy, whether it’s term or permanent. But if you know you also want additional perks, like a non-expiring policy and tax-deferred cash value you can use later in life, whole life insurance is a great option.
➡️ Want to talk to a real person about whole life insurance and cash value? Call us at 800-823-4852! We’d love to help.
Request a Free QuoteThis information is provided for informational purposes only. Please consult with your financial advisor and tax professional on all tax-related financial questions. Your life insurance agent can provide you with an illustration to show possible cash value growth.