A permanent life insurance policy provides two primary financial benefits: death benefit and cash value accumulation. The death benefit is the amount of money the insurance company pays your family if you die. The cash value is a savings component of money that can be accessed during your lifetime.
Learn how these two benefits differ and which you should prioritize when you consider buying life insurance.
Key Takeaways
- Permanent life insurance policies offer both a death benefit and cash value.
- The death benefit is a tax-free payout to your heirs when you pass away.
- Cash value is money you can withdraw or borrow from the policy while alive.
- Taking out cash value reduces the future death benefit for your heirs.
- Any unused cash value is forfeited to the insurer when you pass away, though some policies let you add it to the death benefit for an extra fee.
Life Insurance Death Benefit
Permanent life insurance offers two main benefits to insured individuals: death benefit proceeds and cash value savings. The death benefit is the amount payable to your beneficiaries if you pass away while covered by the policy. Your death benefit (or face amount) is typically shown in the benefits schedule of your policy contract.
While beneficiaries are often one or more family members, they can also be a business partner, an estate, or a charity. Both term life and permanent life insurance policies provide death benefits for the beneficiaries.
The face amount is established when the policy is issued. It may remain the same throughout the life of the policy or it can increase, depending on the type of policy. Insurance companies agree to pay this death benefit as long as the policy remains in force and its premiums are paid.
Beneficiaries can use the funds they receive from a life insurance payout however they want. The death benefit is paid as a tax-free transfer to your named beneficiaries once the insurance carrier is made aware of your death.
Life Insurance Cash Value
With permanent life insurance policies such as whole life or universal life, the policy owner has the ability to accrue savings within the cash value component of the policy. However, temporary term policies do not accumulate a cash value.
The cash value of a life insurance policy equals the total amount of premiums paid minus the cost of insurance and other charges assessed by the carrier. Cash value balances also grow by a return generated by the policy. For example, whole life insurance earns a fixed interest rate. Variable life insurance let you invest the cash value in mutual funds, so your cash value can go up and down based on the investment performance.
Unlike the death benefit, cash value balances are available to you as the owner of a life insurance policy while you are still alive (although there may be a waiting period of several years). You may use the cash value to pay premiums, take out a policy loan, or surrender part of the policy's value for cash.
You can also surrender the entire policy for cash. However, a full surrender will terminate your policy and you will no longer have life insurance coverage. You may be charged a surrender charge, depending upon contract provisions and the age of the policy.
The cash value of a permanent life insurance policy grows tax-deferred. It can eventually be used by the policyholder for a number of purposes, such as funding a policy loan.
Cash Value and Death Benefits
If you take cash value out of your life insurance policy, it reduces the future death benefit for your heirs. If you pass away, any remaining cash value in your policy gets forfeited back to the insurance company, which then pays your heirs the death benefit. Some policies include a rider which adds your cash value to the death benefit, creating a larger payout for your heirs. However, carriers do charge significantly higher premiums for this feature.
Both cash value and death benefit are tied directly to your premium payments. The more death benefit you need, the higher premiums you must pay to cover the cost of insurance. Similarly, paying higher premiums allows your cash value to grow faster. The more you pay, the more you get of each.
With that being said, you can prioritize one goal over the other. It's possible to put more of the premium payments towards building cash value or to creating a larger death benefit. Consider which is more important to you as you design the policy with your insurance agent.
Advisor Insight
Martin A. Smith, CRPC®, AIFA®, RPS®
Wealthcare Financial Group, Inc., Bethesda, MD
The death benefit of a life insurance policy represents the face amount that will be paid out on a tax-free basis to the policy beneficiary when the insured person dies. Therefore, if you were to buy a policy with a $1 million dollar death benefit, your beneficiary will receive $1 million upon your death.
The cash value of the policy represents the portion of savings (or investments, depending on the type of policy that you own) that is funded by a portion of your insurance premiums. This cash value grows on a tax-deferred basis and could eventually be used to pay premiums. It can also be withdrawn tax-free as a loan. You would have to discuss doing so with your insurance carrier, though: if you withdraw too much, you might inadvertently cause the policy to lapse.
What is the difference between death benefit and cash value?
The death benefit (or face amount) is the amount of money your beneficiaries will be paid if you die. The cash value is a fund within your policy that grows as the policy ages and can be accessed within your lifetime.
How can I use the cash value in my policy?
You can withdraw part of the cash value, take out a loan against the balance, use it to pay your premiums, spend it to buy additional insurance coverage, or terminate the entire policy to take out its entire cash surrender value.
Does term insurance have a cash value?
Term insurance does not have cash value. While term insurance provides beneficiaries with a death benefit if the insured passes away, it does not accumulate a cash value that the policy owner can access before death. Only permanent policies build cash value.
The Bottom Line
The death benefit and cash value are both valuable features of a permanent life insurance policy. You should decide which is more important for your financial plan. If your main goal is providing financial security for your family after you pass away, maximizing the death benefit should carry the most weight. However, if you are looking at life insurance as an investment for your own needs, then cash value might be more important.
Bear in mind that both death benefit and cash value have a direct effect on the amount of premiums you will pay. Getting more of either will increase the cost. Talk to your insurance agent to understand the best option for your budget and needs.
