Cash Value Life Insurance

In cash value life insurance, part of the insurance premium is allocated to an investment account that accrues a cash value. Thus, cash value insurance has a dual purpose – first, life-insurance protection and second, attainment of an investment rate of return.

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This dual-purpose aspect of cash value life insurance does not apply to term life insurance. Term life is pure protection in which the policyholder’s premium dollar pays only for the cost of insurance and administration, not for an investment return. The domain of cash value life insurance is permanent insurance – whole life insurance, universal life insurance, variable life insurance, and variable universal life insurance.

Whole Life Insurance

Whole life insurance developed as an alternative to term life insurance. Part of the policyholder’s premium is allocated to a cash-value account. That account draws interest at a rate specified by the insurance company. This rate is protected by a minimum guarantee. Meanwhile, the money is conservatively invested by the insurance company in order to generate the funds to pay the return.

After an interval necessary to generate sufficient cash value, the cash value in the account can be accessed by the policyholder. The policyholder can borrow against the cash value tax-free, up to the limit of the premiums paid to date. Should the insured die, outstanding loans would reduce the amount of the death benefit. Only if the policy lapses would taxes be due on the loan proceeds. The loan could be repaid eventually or, if the insured dies, the loan proceeds could be deducted from the death benefit. Finally, the policyholder can surrender the policy, receiving the cash value or a minimum of premiums paid plus interest.

Cash value life insurance enjoys the important benefit of tax-deferral of investment gains. On the risk/return investment spectrum, cash value life insurance is best viewed as a conservative fixed-income investment, roughly comparable to fixed annuities and high-grade corporate bonds. Its rate of return should be slightly below that of the blue-chip stocks and high-grade bonds in which the insurance companies invest in order to earn the money to fund the cash-value accounts of policyholders.

By definition, whole-life insurance is designed to be held until death or until maturity at age 95 or 100. Upon maturity, the cash value of the policy rises into equality with the policy’s face value and the policy pays out to the policyholder.

Universal Life Insurance

Universal life insurance is a form of permanent insurance in which the premiums and death benefit are more flexible than those of whole life insurance. Payments from the cash-value account achieve this flexibility. For example, once a significant cash value is reached, the policyholder may choose to divert money from cash-value account to pay premiums on the policy or reduce them. Obviously, premium reductions come at the expense of growth in cash value. Similarly, the policyholder may choose to reduce the value of the death benefit in order to reduce the size of the premium paid. This flexibility is aimed at reducing the disadvantage of the high premiums charged by permanent insurance policies. Among the chief beneficiaries of universal life insurance are young families of moderate means who use cash-value flexibility to keep premiums affordable and avoid policy lapse.

The flexibility offered by universal life insurance is magnified when combined with another form of permanent insurance - variable life insurance - and purchased by high-income households.

Variable and Variable Universal Life Insurance

The cash-value accounts of whole-life and universal-life policies pay interest according to fixed rates stipulated in the insurance contracts. The investments that fund those interest payments are controlled by the insurance companies. Variable life insurance offers policyholders the chance to attain higher rates of return and control their own investments. The cash value of the policy is not limited by the death benefit of the policy, as is the case with most whole-life policies. Rather, the death benefit is added to the investment value to comprise the total benefit receive the total benefit received by the beneficiary. The tradeoff is implied in the name; rather than being contractually fixed, the rate of return varies in accordance with market returns and might fall below that provided by whole-life or universal-life policies.

The investment accounts (called “sub-accounts”) in variable insurance are functionally equivalent to mutual funds, offering a mix of stocks and bonds. In addition, the insurance company will also offer a money-market account as a parking place for funds when no investment alternative seems attractive.

Variable life insurance provides a tax-deferred investment outlet for those with an aggressive investment philosophy and a higher tolerance for risk. Tax deferral is the key to understanding the primary uses of variable life insurance, which revolve around exploiting this advantage. When combined with universal life insurance, which adds premium payment flexibility, a formidable tool for high-income policyholders is created.

On its own, universal life insurance is most often used to allow low-income households to lower their premium payments. In contrast, high-income households combine variable and universal life insurance to increase premium payments beyond those required by ordinary insurance need. The purpose is to use the tax-deferred status of insurance to shield as much investment gain as possible from current taxation. Wealthy parents often lower the value of their estates by giving variable universal policies to their children as gifts. This has the dual benefit of providing tax-deferred investments for the children while avoiding estate taxes.

The cash value account in a variable universal policy is a powerful weapon but a two-edged sword. In order to retain its benefits and avoid taxation, the policy must be kept in force, which requires that sufficient premium must be paid to cover the cost of insurance. This actuarially-calculated figure rises yearly as statistical mortality increases. The tax and investment features of the policy must not be allowed to overshadow its insurance requirements.


Cash value life insurance is a feature of permanent insurance policies. These policies provide a wide range of benefits aside from ordinary life-insurance protection. The cash-value feature provides current income, investment principal and loan collateral. The insurance status provides tax deferral for investment gains and for gifts. Cash value adds tremendous flexibility to life insurance, allowing premium payments to be decreased or increased, as appropriate.

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