With whole life insurance, part of each premium goes into a savings-like account inside the policy called cash value. It grows over time according to the contract, and while you're alive you can usually borrow against it, withdraw some, or surrender the policy for it. When you die, your beneficiary generally receives the death benefit, not the death benefit plus the cash value.
Cash value is the feature that makes whole life different from term, and it is also the part people misunderstand most. Here is how it builds, what you can do with it, how it is taxed, and the trade-offs to weigh before you buy a policy for it.
Where cash value comes from
A whole life policy is designed to last for your whole life as long as premiums are paid. To make that work, the premium in the early years is higher than the pure cost of insurance at your age. The insurer sets part of that money aside inside the policy. That reserve is the cash value.
The NAIC describes whole life and universal life as the two main types of "cash value insurance," with whole life premiums usually paid on a set schedule (NAIC Life Insurance Buyer's Guide). Term life, by contrast, usually has no cash value at all.
How it grows
Each whole life contract includes a table of guaranteed cash values by policy year. Those guarantees are backed by the claims-paying ability of the issuing insurer. Growth is usually slow at first, because early premiums also cover the costs of setting up the policy. The NAIC notes that in some cash value policies the values are low in the early years and build later on (NAIC). Expect it to take years, not months, before the cash value is meaningful.
Some whole life policies are "participating," which means they may pay dividends. Dividends are not guaranteed. If they are paid, you can often take them in cash, use them to lower your premium, leave them to grow in the policy, or buy small amounts of extra paid-up coverage. Any projection that includes future dividends is an estimate, not a promise.
Four ways to use cash value while you're alive
- Borrow against it. Many policies let you take a loan using the cash value as collateral. You do not have to qualify for the loan, but interest is charged, and any unpaid loan plus interest is subtracted from the death benefit. If loans grow too large, the policy can lapse.
- Withdraw part of it. Some policies allow partial withdrawals or surrender of paid-up additions. A withdrawal usually reduces the death benefit permanently.
- Use it to pay premiums. Some policies can use cash value or dividends to cover premiums, which can help if money gets tight. Ask how this works in the specific contract.
- Surrender the policy. You can cancel the policy and take the cash surrender value, which is the cash value minus any surrender charges and loans. Your coverage ends when you do.
Every option has a cost, either in interest, a smaller death benefit, or giving up coverage. Before you use cash value, ask for an in-force illustration that shows what the change does to the policy over time.
What happens to cash value when you die?
This surprises many people. On a typical whole life policy, your beneficiary receives the death benefit, and the cash value is not paid on top of it. Think of the cash value as part of how the insurer funds the death benefit over time. Outstanding loans are subtracted from what your beneficiary receives. The NAIC notes the exception: some whole life policies pay both the death benefit and the cash value (NAIC: Life insurance FAQ). Read how your contract handles it.
How cash value is taxed
In general, cash value grows tax-deferred inside the policy, and a death benefit paid to a beneficiary is generally not included in their income (IRS: Life insurance proceeds). Taking money out can be different. If you surrender a policy for more than you paid in premiums, the gain is generally taxable. Loans are generally not taxed while the policy stays in force, but a policy that lapses or is surrendered with a loan outstanding can create a tax bill. Tax rules have exceptions, so talk with a tax professional about your situation.
The trade-offs to weigh
- It costs more than term. For the same death benefit, whole life premiums are much higher, because you are paying for lifelong coverage and cash value. Our guide on how much term life insurance you need explains the term side.
- It is slow to build. Surrendering in the early years can return less than you paid in.
- It is insurance first. Whole life is not an investment account, and its main purpose is the death benefit. People who mainly want growth usually look elsewhere; people who want permanent coverage with a savings component often find whole life fits.
Whole life is not the only permanent option. Indexed universal life (IUL) also builds cash value, with more flexibility and fewer guarantees. And if your main goal is covering a funeral, a small whole life policy may do the job, as explained in final expense vs. life insurance.
Questions to ask before you buy
- Which values in the illustration are guaranteed, and which assume dividends?
- What is the guaranteed cash value in years 5, 10, and 20?
- What is the loan interest rate, and is it fixed or variable?
- Are there surrender charges, and for how long?
The bottom line
Cash value is a built-in reserve that grows slowly and can give you options later, such as a loan or extra flexibility with premiums. It comes with a higher premium and some trade-offs. An independent agent can compare whole life policies from several carriers and show the guaranteed and non-guaranteed columns side by side. Request a free quote, or start with our whole life insurance guide.
Frequently asked questions
How long does it take whole life insurance to build cash value?
It depends on the policy, but growth is usually slow in the early years because early premiums also cover the cost of setting up the policy. The contract's table of guaranteed values shows the cash value by year, so you can see when it becomes meaningful.
What happens to the cash value when I die?
On a typical whole life policy, your beneficiary receives the death benefit, and the cash value is not paid in addition to it. Any outstanding policy loans are subtracted from the payout. Some policies or riders handle this differently, so read your contract.
Can I cash out a whole life policy?
Yes. You can surrender the policy and receive the cash surrender value, which is the cash value minus any surrender charges and outstanding loans. Your coverage ends when you surrender, and any gain over what you paid in premiums is generally taxable.
Is whole life cash value taxed?
Generally, cash value grows tax-deferred while it stays in the policy. Surrendering for more than you paid in premiums generally creates taxable income, and a policy that lapses with a loan outstanding can also trigger tax. Ask a tax professional about your situation.
What are whole life dividends?
Some whole life policies, called participating policies, may pay dividends. Dividends are not guaranteed. If paid, you can often take them in cash, use them to reduce premiums, leave them in the policy, or buy extra paid-up coverage.
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This article is general and educational, not an offer to sell insurance or financial, tax, or legal advice. Coverage, benefits, and availability vary by carrier, product, and state, and all coverage is subject to underwriting.