Life Insurance Savings Accounts: What You Should Know

If you purchase a permanent life insurance plan, it will likely include a savings account, which is known as the cash value component. As money accrues in this account, policyholders may use the savings at their discretion. However, to fully understand the practical value of a life insurance savings account, there are a few things you should know.

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What Is a Life Insurance Savings Account?

A life insurance savings account is the cash-value component of a permanent life insurance plan. This account, which accumulates value over time, is separate from the plan’s death benefit and can be used during the policyholder's lifetime without voiding the policy. The money saved in this account typically has a tax-deferred status so the value can be grown more quickly than in a traditional savings plan.

How Is a Life Insurance Savings Account Funded?

Your policy’s terms dictate how a life insurance savings account is funded. For many plans, the account is funded using a percentage of the policy’s premium payments. If your plan pays dividends, you may be permitted to reinvest some or all of the payments into your account’s cash-value component.

Some policies may also let you make additional payments into your plan’s savings account. However, if the cash value exceeds a certain amount, it may be considered overfunded and can lose its tax-advantaged status. Your financial advisor or a representative from your insurance company can educate you on the limits and guidelines for your individual plan.

Does a Life Insurance Savings Account Increase the Cost of My Policy?

Life insurance savings accounts are only included in permanent life insurance policies, which are more expensive than term plans, so you’ll typically pay more if you want this component. However, the cost of a life insurance policy is affected by numerous factors, including:

• The type of plan
• The coverage amount
• The insurance company
• Your age, gender, health and lifestyle risk factors
• Any riders you add on

How Can a Life Insurance Savings Account Be Used?

Once your life insurance savings account reaches a certain amount, as determined by the insurance company, you may withdraw or borrow against its value. Typically, insurers don’t place restrictions on how these funds may be spent, and policyholders may use them to:

• Reduce or eliminate insurance premium payments
• Handle emergency expenses
• Supplement retirement income
• Pay for long-term care needs

Depending on your insurer and the individual policy, you may also be able to use your cash value to increase the policy’s death benefit.

How Does the Cash Value Component Differ Between Whole and Universal Life Insurance Plans?

How a life insurance savings plan grows its earnings can differ considerably depending on whether you purchase a whole or universal life policy.

Whole Life Insurance Cash Value Accounts

Whole life insurance has the simplest guidelines for its cash value component. These plans offer fixed monthly premiums and guaranteed death benefits. The savings account grows at a fixed rate, which is determined by the insurer, so there's no risk of loss. Plus, if the company issues annual dividends, these typically may be reinvested into the cash-value account.

Universal Life Insurance Cash Value Accounts

Universal life policies vary considerably by type, and some options don’t accumulate cash value well. Here’s what you can expect by policy type:

• Guaranteed universal life insurance. The cash-value accumulation under a guaranteed universal life insurance plan is often minimal. However, these plans are often the least expensive type of universal life insurance and typically have convenient, fixed premiums.
  
  
• Variable universal life insurance. Variable universal plans are designed for flexibility. Accordingly, the cash-value component is tied to investments, such as stocks, bonds and mutual funds, which are chosen by the policyholder. However, unlike accounts that offer a fixed minimum rate of return, the cash component of a variable universal plan can lose money.
  
  
• Indexed universal life insurance: The cash-value component of an indexed universal life insurance plan is typically based on the performance of a major financial index, such as the S&P 500. However, because your money isn’t directly invested in the stock market, your insurer may set floors and caps so your gains and losses won’t completely reflect the market’s performance. That means you typically won’t lose money in an indexed plan. However, the amount of money you can earn may also be limited. Some IUL plans also offer fixed-rate options similar to those of whole life policies.

How Can I Benefit From a Life Insurance Savings Account?

Although a permanent life insurance policy with a cash-value component can be more expensive than a simple term plan, there are several benefits that come with a life insurance savings account.

• Lifetime access: Because cash-value accounts are typically attached to permanent life insurance policies, the plan won’t expire. Essentially, once funds accrue sufficiently in your life insurance savings account, you’ll have access to them throughout your life.
  
  
• Ease of loans: Because the money you’re borrowing against is yours, taking out a loan against your life insurance savings account is quick and easy and doesn’t involve a credit check. Plus, these loans are typically paid back at a low interest rate that you can't get through a commercial lender.
  
  
• Supplemental retirement funds: If you’ve hit the ceiling on contributions to your retirement fund, you can put aside additional money through your life insurance policy's cash value component with similar tax-deferred benefits as 401(k)s and other popular plans.

Do Life Insurance Savings Accounts Have a Downside?

Because permanent life insurance can be costly, the major downside to a life insurance savings account is the price. However, there are several other potential pitfalls you should watch out for, including:

• A policy lapse. You can typically use your life insurance savings account to satisfy premium payments. However, if you completely drain money from the account, you risk having your policy lapse.
  
  
• Reduced death benefits. If you borrow against your policy’s cash value and don’t pay it back in full, you may reduce the amount of the death benefit your beneficiaries receive.
  
  
• Forfeiture of funds: Most life insurance policies won’t pay out the cash value to your beneficiaries, so you risk losing your money if you don’t use it before you die.

What Happens to Your Life Insurance Savings Account If You Die?

Once your beneficiary files a death benefit claim, the cash value on your account stops growing. What happens to your remaining funds depends on the type of policy you have and the terms of your individual policy.

Unfortunately, because the cash value is separate from the death benefit, your beneficiaries can't access it, and most insurance companies simply absorb any remaining funds after you die. Although some insurers offer policyholders the option of using unused funds to increase the death benefit payout through a paid-up additional insurance rider, exercising this option often comes at a cost. A representative from your insurance company can help you learn more about your policy's specific guidelines.