Cash Value Life Insurance Policy: How it Works

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Picture of By <span>Matthew Roberts</span>
By Matthew Roberts

Updated on January 3, 2025

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Picture of By <span>Matthew Roberts</span>
By Matthew Roberts

Updated January 3, 2025

Visit author page

4 minute read

Article Contents

Cash value life insurance is a type of permanent life insurance that includes both a death benefit and a cash value component – but it goes a little bit deeper than just that.

Unlike term life insurance, which provides coverage for a specific period, cash value life insurance remains in force for the policyholder’s lifetime as long as premiums are paid. This more comprehensive coverage offers both a financial safety net for beneficiaries and a savings or investment vehicle for the policyholder.

Cash Value Life Insurance at a Glance

  • Whole life insurance cash value accumulates over time, and therefore may not be worth too much early on.
  • Cash value life insurance generally costs more than term life.
  • Policyholders can borrow from the policy’s cash value, but there are some caveats.
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Cash Value Life Insurance Explained

If you’ve ever found yourself wondering “what is cash value life insurance, exactly?” then you’ve come to the right place.

Simply put, cash value life insurance is an umbrella term used to refer to whole life policies that contain a cash value component. It combines the traditional death benefit (the amount paid out to beneficiaries upon the policyholder’s death) with an investment or savings element. 

Because of this, premiums for cash value life insurance in Canada can be higher than their term life counterparts. As you make these regular payments, the policy’s tax-deferred cash value begins to grow. It’s kind of like making small deposits into the policy on top of paying off the premiums and interest. The growth rate depends on the type of policy and the insurer’s terms.

Benefits & Drawbacks of Cash Value Life Insurance

How to Withdraw from The Cash Value

The cash value of a life insurance policy can be accessed by the policyholder during their lifetime, providing a versatile financial resource that can be used for various purposes. 

Policyholders can access the cash value of their life insurance in several ways:

Policy Loans:

This is when policyholders borrow against the cash value, typically with favourable interest rates. These loans do not require credit checks and can be used for any purpose, such as paying premiums or covering personal expenses. Do note that these have to be paid back eventually, since these loans diminish the overall death benefit or cause the policy to lapse. 

Withdrawals:

In this case, you would be taking direct withdrawals from the cash value. Withdrawals are generally tax-free up to the amount of premiums paid, but any amount above that may be taxed. In some cases, these are called “partial surrenders” since you’re giving up the death benefit, but this is largely case-specific. Regardless, there’s usually a maximum amount you can withdraw from your policy.

Paying Premiums:

Another good use for the policy’s cash value is when it’s used to cover future premium payments, effectively reducing out-of-pocket costs. This can be an excellent strategy when you hit retirement age, since it keeps the policy in force while avoiding taking from your pension or retirement savings. 

Surrendering A Policy For Cash Value

Policyholders have the option to “surrender” their insurance policy, which basically means you’ll be terminating it before anything is actually paid out. This can be done to access the plan’s full cash value, but it doesn’t come without a few drawbacks. Surrendering a policy often comes with penalties and fees, particularly in the early years of the policy. This is on top of any taxes you’ll also have to pay. 

But if you’re past the point when surrendering your policy incurs large fees because of the plan’s age, you’re able to choose between a lump sum payment or incremental payments. However, some policies don’t allow for this level of flexibility and will have the terms laid out in your contract. 

Different Kinds of Life Insurance With Cash Value

Cash value components are quite attractive to many people, but they’re a little bit different depending on the kind of policy you end up purchasing. Here are some of the most common life insurance policies that include a cash value element:

Variable universal life insurance allows policyholders to invest the cash value in various sub-accounts, similar to mutual funds. These accounts contain investments of your choosing, so it really is more of an investment product than anything. The cash value and death benefit can fluctuate based on the performance of these investments – but you can set hard limits on the minimum and maximum values. 

As a general rule, this type of policy offers potential for higher returns but comes with greater risk compared to other types of cash value life insurance.

Indexed universal life insurance links the cash value growth to a stock market index, such as the S&P 500 or the S&P/TSX Composite Index. This provides an opportunity for cash value growth based on market performance, with typically some level of protection against market losses.

Universal life insurance provides flexibility in premium payments and death benefits. Policyholders can adjust their premiums and death benefits within certain limits, allowing for customization based on changing financial needs. Do note that the cash value earns interest at a rate set by the insurer, which may vary over time.

Whole life insurance offers a guaranteed death benefit and a guaranteed cash value growth rate. Premiums are fixed for the life of the policy, providing stability and predictability. This makes it a good option for folks who want to “set it and forget it.” Its predictable nature also makes it a feasible option for people who just want to build a safety net later in life. 

In short, whole life insurance typically has higher premiums compared to other types of life insurance, but it offers the most certainty in terms of benefits and cash value accumulation.

Guaranteed issue life insurance is a form of whole life insurance that doesn’t need a medical exam or health questions, ensuring you can’t be denied coverage.

While it might build some cash value over time, the coverage amounts are typically modest, resulting in a relatively small cash value. This type of policy often comes with a graded death benefit, meaning if the insured person passes away within the first two or three years (unless due to an accident), the beneficiaries won’t receive the full payout.

Key Advice from MyChoice

  • Cash value life insurance provides both a death benefit and a savings component.
  • It’s a very versatile tool for providing for your family while serving as a financial safety net.
  • Different kinds of cash value policies have disparate terms, so researching before buying is essential.

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