What is Cash Value in Life Insurance?

What is Cash Value? 

Cash value is a savings component in life insurance policies such as whole life insurance plans, that accumulates over time as you pay premium amounts. It grows with interest or investment returns and can be accessed while you’re still alive through loans, withdrawals, or by using it to pay premiums. Unlike term insurance plans that only offer a death benefit, cash value in life insurance combines a death benefit with a survival benefit. 

1. Purpose of Cash Value 

   Cash value helps serve various purposes within an insurance plan, offering potential benefits to the policyholder during the policy term. It increases the financial value of a policy by offering different opportunities for borrowing, policy surrendering, or as a supplemental income source. 

2. How Does Cash Value in Life Insurance Work?

   A portion of each premium payment goes towards the life coverage i.e., the death benefit and another portion goes into the account of cash value. 

   This cash value grows with time, often tax-deferred. 

   The cash value amount that can be accessed is called the surrender value and may be reduced by surrender charges, primarily in the event of early plan cancellation. 

3.  Let’s understand with the help of an example:

   For example, suppose you have a life insurance policy with a Sum Assured of ₹1 crore and a cash value of ₹25 lakh. On your death, most Indian policies will only pay ₹1 crore (the death benefit) to your nominee. The insurer retains the ₹25 lakh cash value and is not an additional payout. The nominee may receive both in some ULIPs with the “Sum Assured + Fund Value” option. Always check your policy terms carefully.

   Cash value adds a savings and wealth creation feature to your life insurance life cover. This feature splits your premiums into two parts:

   • A portion of your money goes into savings and wealth creation. The remaining amount earns interest to build cash value.

   • The remaining premium is used to cover the cost of the financial security.

   Over time, when your account has accumulated enough cash value, you can either receive the accrued cash value at maturity or apply for loans during the policy term in case of a financial emergency.

4. How Can You Use It? 

   There are several flexible ways you can use your policy's cash value:

   • Borrowing: You can take a loan against the cash value, but remember that any unpaid loan amount will reduce the final payout (death benefit) your family receives.

   • Withdrawals: You are allowed to withdraw money directly from the cash value. Be aware that this also lowers the death benefit and may be taxable if the amount withdrawn is more than the premiums you’ve paid in total.

   • Paying Premiums: The cash value can be used to cover your future premium payments, which is a great option if you face a financial emergency or job loss.

   • Supplementing Income: You can use the cash value to meet other financial needs, such as supplementing your retirement income or funding major expenses later in life.

Types of Life Insurance Policies That Build Cash Value

To understand how cash value works, it helps to know which plans actually offer this benefit. Only permanent plans accumulate savings over time. These include whole life insurance, endowment plans and ULIPs. Whole life and endowment plans grow cash value at a steady interest rate, while ULIPs build cash value based on market-linked fund performance. Term life insurance does not build any cash value. This section helps readers compare different policy types before choosing the right plan.

What Happens When You Withdraw Cash From Your Life Insurance Policy?

When you withdraw cash from your life insurance policy, it affects your coverage in a couple of ways:

• Death Benefit Decreases: Each time you withdraw money, the amount your beneficiaries will receive upon your passing decreases by the same amount.

• Policy Termination: If you withdraw all the cash value in your policy, the policy itself will end, and you won't have any coverage.

Here are some tax implications upon withdrawal of cash from your life insurance policy:

• Premiums: You can withdraw the amount you’ve paid in premiums without paying taxes, as this is a return of your money.

• Earnings: Any additional money earned from dividends or interest on your premiums is subject to taxes. You'll only pay taxes on these earnings after you've taken out all the premiums you've put in.

How Does Cash Value Accumulate in a Life Insurance Policy?

Your life insurance policy's cash value takes time to grow, and the growth rate is usually limited to the minimum guaranteed rate. Life insurance policies like endowment and whole life insurance plans accrue cash value, whereas most term insurance plans do not. Term plans do not offer this benefit because of their shorter coverage period.

Here is how the whole life insurance cash value is accumulated.

• A portion of your premium goes into the policy's savings component, which earns interest and grows over time.

• As you get older, the risk of you increases.

• To manage this, the insurer allocates a larger share of your premium towards life cover and reduces the share going into the cash value.

• This shift slows down the accumulation of cash value in later years.

• You can use a cash value life insurance calculator to check the accumulated amount at any policy stage.

What are the Ways to Access the Cash Value of Life Insurance Policy?

You can access the cash value in life insurance amount in any of the following ways 

• Making Cash Withdrawals: A portion of the premium is allocated as savings in life insurance policies, accumulating interest over time. You can access this accumulated cash value of life insurance by making cash withdrawals.

• Taking Loans Against Policy: You can also access the collected cash value by taking a loan against the cash value of your life insurance policy. The amount of loan you can take depends on the policy’s T&Cs, but most life insurance plans provide 90% of the cash value as loans in case of an emergency. This is a good option for those facing a financial emergency, as using life insurance as collateral results in lower interest rates on the loan amount.

• Surrendering the Policy: Another way to access your cash value life insurance is to surrender the Life Insurance policy. Usually, people surrender their policy if the policyholder is unable to pay the premiums and, after surrendering, receive an amount lower than the cash value. This option is not advisable, as after surrendering, the policyholder will no longer be covered under the policy benefits, and thus in case of an eventuality, the family will not be eligible to receive any benefit amount.

How Can I Use the Cash Value in Life Insurance?

You can use the cash value of life insurance in the following ways:

• Fund Medical Emergencies: Unexpected financial emergencies can arise at any time. You can use the cash value life insurance to fund medical emergencies by making cash withdrawals or taking loans against the policy.

• Post-retirement Expenses: You can cover your post-retirement expenses using the accumulated cash value of life insurance. 

• Pay for Hospital Bills: Hospital bills can be expensive; thus, it is better to use cash-value life insurance to pay for the mounting hospital bills in times of need.

• Policy Outlives its Purpose: Many people buy life insurance plans for a specific purpose, and once the purpose is served, they don't see the need to continue their life insurance policy. You can terminate the policy and receive the accrued cash benefit in such cases.

Is Cash Value Life Insurance Tax-Free?

The short answer is: Yes, the cash value can be tax-free, but only if it meets specific conditions under Section 10(10D) of the Income Tax Act, 1961. This exemption applies to the maturity benefit, surrender value, and any bonuses received. The key conditions are tied to the premium paid relative to the sum assured and the policy's issuance date. For policies issued after April 1, 2012, the annual premium must not exceed 10% of the sum assured to qualify for this tax exemption. There are also specific rules for ULIPs and high-premium policies that were introduced in recent years.

What are the 4 Factors that Affect the Cash Value Life Insurance in India? 

Here is a list of all the factors that impact the cash value life insurance in India.

• Policy Duration:
  The longer the policy has been active, the more will be the cash value of life insurance. This is because the savings portion collects interest, and the longer the amount collects interest, the more will be the cash value.

• Premium Amount:
  The premium amount paid affects the cash value of life insurance as a portion of the premiums collects the interest, which becomes the cash value. Thus, the larger the premium, the more will be the accrued cash value life insurance.

• Fund Market Performance:
  A lot of the life insurance plans that offer cash value are market linked, and the performance of funds impacts the accumulated cash value.

• Previous Cash Withdrawals:
  Any previous cash withdrawals made will reduce the cash value of life insurance. This is because the withdrawals are made from the collected cash value.

*Note: It is suggested to calculate the term plan premium on the term insurance calculator online tool by Policybazaar before buying.

Key Points To Remember 

• You should always review your life insurance policy documents to see if the policy accrued cash value and how you can access the accumulated amount.

• The cash value feature does not apply to term insurance policies.

• Only whole life covers, or endowment-based insurance policies accumulate cash value.

• Regular premium payments for a minimum of 2 to 3 years are mandatory for the policy to start acquiring a cash value.

• You may not be entitled to the whole cash value accumulated by your policy. This is subject to the terms and conditions set forth by the insurer.

• The death and maturity proceeds from an insurance policy will be reduced based on how much you have withdrawn from your cash value account.

Wrapping it Up!

Life insurance policies in India usually invest a portion of the premium paid towards the insurance part, and the other portion is used to save for wealth creation. The latter portion collects interest as per the applicable interest rate over time and allows policyholders to access this amount as per their needs. You can use the cash value life insurance amount to pay off any financial emergencies or unexpected expenses. 

Note: Check all the best term insurance plan in India.

Note: You should also check the benefits of term life insurance if you are planning to purchase the term insurance plan.

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