If you buy a permanent life insurance policy — typically whole life or universal life — you’ll have both a death benefit and a cash value component to your policy.
Understanding the differences between the two and how they can affect each other can prevent you from selling your loved ones short. Also, knowing whether you need them both can be important when you’re creating your financial plan.
Death benefit vs. cash value: What’s the difference?
Regardless of what type of life insurance policy you buy, the main feature is the policy’s death benefit. This is what your beneficiary gets if you die before the policy’s term ends, as long as you make your regular payments.
While some policies come with increasing and decreasing death benefits, most offer a level benefit that stays the same. In most cases, the beneficiary receives the death benefit tax-free.
If you buy whole or universal life insurance, you’ll also get a cash value feature. This cash value grows tax-deferred over time, slowly at first then exponentially after 15 to 20 years. You can borrow from it tax-free at a relatively low interest rate or access it by surrendering the policy.
In most cases, you don’t get to keep both the cash value and the death benefit. Plus, cash value policies are typically much more expensive than term insurance policies that only offer a death benefit.
How your cash value affects your death benefit
For the most part, your death benefit and cash value don’t affect each other. The main impact comes when you borrow against your cash value. After taking out the loan, you can choose whether or not to repay it.
If you don’t, the insurance company deducts the amount of the loan from the policy’s death benefit if you die before the policy’s term ends. Since you can typically borrow up to 90% of your policy’s cash value, your loan could cause financial distress for your loved ones if it’s a significant portion of your policy’s death benefit.
Another way your cash value can affect your death benefit is by keeping it intact. With universal life insurance, you can typically use the cash value from a permanent life insurance policy to pay your premiums for you.
You typically have to be careful about doing this, however, because the policy can lapse once your cash value hits zero. And when the policy lapses, you lose the death benefit.
Is a cash value policy right for you?
As we mentioned previously, permanent life insurance policies that offer cash value are usually much more expensive than term life insurance. So, for the average person on a budget, a term insurance policy might be a better option.
But if you have any of the following needs, a permanent policy with cash value could be worth it:
You need lifetime coverage
If you have a chronic health condition that makes it hard to save for the future, having lifetime coverage can ensure that your loved ones are taken care of if something happens to you.
Having lifetime coverage can also help if you want to leave a legacy, either through an inheritance or a big donation to a charitable organization, but are confident that you’d outlive a term policy.
You want some extra retirement savings
If you’ve maxed out all of your retirement accounts (i.e., 401(k), IRA, etc.), you may be looking for other tax-advantaged ways to save for the future.
Because cash value earnings grow on a tax-deferred basis, some people use permanent life insurance as an alternative way to save for retirement.
Keep in mind, though, that it often takes 15 to 20 years for your cash value to grow at a significant enough pace to make a difference. So, this strategy is best if you have enough retirement funds to last until your cash value growth is enough.
You know what you’re getting yourself into
Cash value life insurance is more complicated than term life insurance, and it matters where you get it. Avoid applying for a policy if you’re not quite sure you understand how it works, even if the life insurance agent is pressuring you.
Also, consider getting a second opinion from a financial advisor who doesn’t sell life insurance to make sure that cash value life insurance fits well with your financial plan.
The bottom line
While every life insurance policy has a death benefit, only permanent insurance policies offer cash value.
If you’re considering a life insurance policy, consider making it your top priority to get the right amount of death benefit. Then if you can afford it and your situation merits it, consider getting a cash value policy that can provide some extra benefits.
At Leap Life, our team of licensed life insurance experts can help you walk through the process of deciding how much coverage you need and what type of policy is best for you. They can also answer any questions you have along the way.
As you do your due diligence with this process, you’ll be able to provide the protection your loved ones need while also meeting your other financial goals.