Cash value life insurance is a type of permanent life insurance. It provides death benefits, as well as a savings feature. Each premium gets split into policy coverage and investment. It is this investment portion that provides the life insurance with its cash value.
Much of the interest in cash value life insurance originates in retirement planning. If it will provide sufficient supplemental income is something that a financial advisor and a policy agent can discuss.
Cash value life insurance grows tax-deferred. So, the interest it accumulates does not get taxed during the lifetime of the policy. Interest is only taxable when it is withdrawn. There are two ways to keep withdrawals tax-free.
One way is to withdraw amounts only from deposits made towards the premiums (or your cash basis), and not those made towards the cash value. This is considered a return on principle, and it is not considered income.
A second way is to withdraw in the form of a loan. A loan will not be taxable; however, you will owe the loan plus interest to the insurance company.
Caution: it is possible to go over with withdraws from your account and end up withdrawing from the cash value. The danger of this is that you may end up lapsing the policy. If this happens, and you happened to have accumulated a substantial cash value, interest will become taxable in the year you withdraw it. Cash value life insurance offers the option to surrender the policy. This is essentially a total distribution of the policy (minus any surrender fees the company charges). If proceeds were more than your cash basis, proceeds will be reported on Form 1099-R.
It’s important to note that cash value is only available on permanent life insurance, not term life insurance. Cash value life insurance premiums are higher than on term policies, along with policy and surrender fees. It’s important to be prepared with a list of questions when speaking with both an advisor and an insurance agent in order to avoid costly surprises down the road.
the Confident Taxpayer 