How the cash value of a life insurance policy grows, depends upon what policy you own, its provisions and the life insurance company itself.
Known as permanent life insurance, also called cash-value life insurance, has a cash value that grows over time, as well as a death benefit. Other insurance policies that have a built-in cash value include variable, whole and universal life insurance. Term life has no cash value.
When the cash value in permanent life insurance has accumulated to some size, you can use the funds to:
- Pay your policy premium;
- Take out a loan at a lower rate than banks offer;
- Create an investment portfolio that maintains and accumulates wealth; or
- Supplement your retirement income.
Investopedia’s recent article, “How Cash Value Builds in a Life Insurance Policy,” explains how the process typically works.
When you pay the premium on a cash-value life insurance policy, part of the payment goes to the policy’s death benefit (based on your age, health and other underwriting factors). Another portion covers the insurance company’s operating costs and profits. The remainder of the payment is attributed toward your policy’s cash value. The life insurance company will invest this money in a conservative-yield investment. As you continue to pay premiums on the policy and earn more interest, the cash value increases.
With a cash-value life insurance, you generally pay a level premium. In the early years of the policy, a higher percentage of the premium goes toward the cash value. However, with time, the amount earmarked to cash value decreases.
Each year as you get older, the cost of insuring your life gets more expensive for the life insurance company. That’s why the older you are, the more it costs to purchase a term life policy. When it comes to cash-value insurance, the insurance company will add in these increasing costs.
The cash value accumulation will vary, based on the type of policy you have. Whole life policies provide “guaranteed” cash value accounts that grow according to a formula determined by the insurance company. Universal life policies accumulate cash value based on current interest rates. Variable life policies invest funds in subaccounts, which operate like mutual funds. The cash value grows or falls, based on the performance of these subaccounts.
Here's something to dig into: depending on the policy, the cash value of your policy may return to the insurance company and not your heirs. Have a conversation with your insurance advisor and your estate planning attorney to calculate the policy’s potential cash value and provisions and maximize the return to your estate.
Reference: Investopedia (April 30, 2018) “How Cash Value Builds in a Life Insurance Policy”