If you have a whole life insurance policy, you may hear two numbers related to the value of your policy: Cash value and face value.
The face value of your life insurance policy is simply the amount of money your beneficiaries receive when you die, and they file a claim to collect on the policy.
You should be aware of the face value of your policy when you purchase life insurance. You want to make sure the face value will be enough to cover any funeral expenses and also provide for your loved ones after you’re gone.
Except in certain rare circumstances, which we will cover below, the amount of the death benefit – or face value - won’t change. That money is also typically not subject to income taxes, so your loved ones can count on receiving the full amount without a tax liability.
The cash value of your whole life insurance policy shows how much value the policy has accrued. When you pay into your whole life insurance each month, some of the premium goes into a dedicated account, which builds value over time.
Instead of just paying into the death benefit of your insurance policy, you are making an investment. The value of your policy may grow quickly depending on current interest rates and the investments your policy is tied to.
Your whole life insurance policy can supplement a 401K, stocks, bonds, and any other investment products you may have.
Even better, that investment is tax deferred. If you are looking to reduce your annual tax bill without increasing your withholding numbers, investing in a whole life insurance policy is one way to do so.
The money in that tax-deferred account at any time is considered the cash value of your whole life insurance policy.
Understanding your life insurance policy’s cash value gives you access to funds you can use for practically anything. You can withdraw cash from your policy, surrender the policy to receive the value in cash (minus any fees and taxes you’ll have to pay), or you can borrow money from the insurer, using the cash value of your policy as collateral.
Let's explore these options:
Policyholders realize a number of benefits to borrowing against the cash value of their whole life policy.
You can draw from that money at nearly any time for many purposes. You just have to wait until your policy has accumulated a certain value, which typically occurs once you’ve been paying premiums for five to 10 years. At that time, you can borrow up to 90% of the cash value, using your policy’s cash value as collateral against the loan.
Borrowing against your whole life policy makes sense for a lot of people for many reasons. A life insurance loan typically requires no income check and no credit check. In fact, all you’ll have to do is verify your identity and that you are the policy holder.
Interest rates on these loans are typically lower than personal loans or credit cards because they are backed by the cash value of your policy. You may find lower interest rates with a home equity loan, but if you fail to make the payments on a home equity loan, you could lose your house.
On the other hand, when you borrow against your whole life policy, you don’t have to make fixed monthly payments that go toward the principal. You can pay the money back at your own pace.
Depending on how much you borrow, you may have to cover the annual interest payments on the loan. However, if the total of the loan plus accumulated interest doesn’t exceed the policy’s cash value, you don’t even have to pay interest until you are ready to pay off the loan.
If makes sense to pay back the loan as quickly as possible because interest charges will compound annually. If the loan exceeds 90% of the policy’s cash value, you could lose your coverage.
In addition, should you die with a loan outstanding, the insurance company will reduce your death benefit by the amount of the loan, which could leave your beneficiaries short of cash for important expenses.
If you’d rather not make loan payments, some whole life policies let you withdraw funds of up to 90% of your policy’s cash value.
This decision has a number of drawbacks. You won’t collect interest on the money, which you would if you simply borrowed against the loan instead of withdrawing the cash.
Additionally, by withdrawing from the cash value of your policy, you’ll reduce the value of your death benefit, or the face value of your policy.
Finally, since your premium payments were made pre-tax, you’ll have to pay income tax on the funds withdrawn at your usual tax rate.
As a last resort, some people who find themselves in a cash crunch may consider surrendering a whole life policy. If you do this, you will receive the accumulated cash value of the policy.
But you will lose the death benefit, so if you should pass unexpectedly, your loved ones may be left without the financial support they need.
Additionally, you’ll have to pay taxes and fees, which will reduce the total amount you can collect.
Understanding the face value vs. cash value of a whole life insurance policy can help you compare policies, premiums, and benefits and help you choose the life insurance plan that is best for you and your loved ones.