The two types of life insurance policies are term life insurance and permanent life insurance. The premium for permanent life insurance is generally higher than term life because part of your premium is invested in an interest-bearing account that grows tax deferred. The investment portion of a permanent life insurance policy is known as the cash value.
Types of Policies
Cash value is built into permanent life insurance policies, such as whole life insurance, universal life insurance and variable life insurance. These policies act as a savings account that you can later borrow against. Term life insurance does not offer a cash value savings feature.
Uses of Cash Value
You can borrow against the cash value of your permanent life insurance policy to pay for large expenses or to supplement your emergency fund. The money borrowed against a cash value policy does not have to be repaid. If you choose not to repay the loan the insurance company will deduct the amount of the loan from the death benefits paid to your survivors. You can also choose to use the cash value to further your investment portfolio by purchasing annuities or saving for retirement.
Advantages
The savings within a cash value policy grows tax deferred until you withdraw the money. According to the New York State Insurance Department, money withdrawn from a cash value policy is not taxable as long as the amount you borrow does not exceed the amount of premium you have paid into the policy.
You can also surrender a permanent life insurance policy for the full cash value
Disadvantages
Due to the forced savings feature, permanent life insurance policies that build up a cash value are generally more expensive than term life insurance. Also the cash value within the policy does not build up immediately and is not paid out in addition to the death benefits.
Cash Value Vs Face Value
People unfamiliar with permanent life insurance often incorrectly use the terms cash value and face value interchangeably. Cash value, the savings amount built up within the policy, is based on the amount of premiums paid into the policy and can be borrow against while face value is the amount of benefits the insurance company will pay your beneficiaries when you die.
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