Cash Value Life Insurance Explained: Is It Worth it?
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What is cash value life insurance?
Cash value life insurance is not actually a product type, but rather a type of permanent life insurance (whole or universal) that includes cash value in addition to a death benefit.
- A cash value component: A tax-deferred savings feature which grows over time and can be borrowed from or withdrawn while you’re still alive — but it counts against the death benefit.
- A death benefit: The tax-free lump sum payout your beneficiaries receive when you pass away.
While cash value insurance policies are sometimes described as “an insurance product and an investment in one,” that’s not a fair picture.
In truth, cash value policies are often far more expensive than traditional life insurance policies — and for the average Canadian, these policies are generally unnecessary.
Types of life insurance with cash value
There are two main types of permanent life insurance that may offer cash value components:
Permanent policies that offer cash value:
Whole life and participating: Cash values typically grow at a guaranteed rate.
Universal life: Cash value growth is often less predictable and riskier, since there are more investment options and value depends on market performance.
No, the cash value of a permanent life insurance policy is not free money. Permanent life insurance policies with cash value components typically cost 5 to 15 times more than a term life policy because a portion of the premiums is used to fund the cash value savings component. On top of that, withdrawals or loans typically incur fees, interest, or a reduced death benefit.
How does cash value life insurance work?
Cash value life insurance policies work because part of your premiums go toward the policy’s cash value, which grows tax-deferred. The exact functionality and growth depend on your policy type, but you’re allowed to tap into that cash value (unlike with term insurance).
Bottom line: Cash value is funded by you and grows tax-deferred over time, based on the type of permanent policy.
How does the policy generate cash value?
Your premiums partially fund the cash value. A premium for a cash value life insurance policy is split into three parts:
- Insurance coverage: This part of your premium contributes to your death benefit, which is the guaranteed tax-free lump sum paid out to your beneficiaries when you pass.
- Fees and administrative costs: This part of your premium covers the provider’s fees and administrative costs.
- Cash value savings: This part of your premium is invested in the policy’s cash value, which grows over time in a tax-deferred savings account.
Your actual cash value will depend on the type of policy:
- Whole life cash value growth happens at a low, minimum guaranteed rate.
- Universal life cash value growth is less predictable because it depends on the performance of the investments you choose).
If you have a participating whole life policy, then your cash value policy has a bonus component where you can earn dividends based on your life insurance company’s own financial performance.
Dividends from participating whole life cash value policies can be:
- Taken as cash
- Used to buy more life insurance coverage (increase the death benefit)
- Used to reduce premium payments
- Used to increase the policy’s cash value
Most policyholders do not see significant cash value growth until 10 to 15 years after buying the policy. Most of your premium covers the policy’s cost and administrative fees, and only a small amount is added to the cash value fund with each premium payment.
Yes. Some insurance providers offer limited-pay whole life insurance policies, which give you the option to pay up your premiums over a shorter period (e.g., 8, 10, 15, or 20-year pay plans).
Since you’re paying higher premiums to the policy early on, the cash value can build sooner. The only drawback is that limited-pay policies are generally way more expensive than traditional whole life policies, which makes them unaffordable for most families.
How do you borrow from the policy’s cash value?
Most insurance providers allow borrowing against the policy’s cash value. In this case, the policy’s cash value is used as collateral for the loan, and the insurance company charges an interest rate until it’s repaid.
The advantage of cash value policies is that, once you have accumulated enough cash value, you’re allowed to tap into those savings while you’re still alive:
- Withdraw from their cash value
- Borrow against it
- Use it as collateral for a loan
The drawback of cash value policies is that every withdrawal affects you negatively:
- Reduces the death benefit payout for your beneficiaries
- Interest is charged until it’s repaid
- Defaulting could mean the company seizes your cash value to cover the loan
- Taxes may apply if you withdraw above the adjusted cost basis (ACB), surrender the policy, or if the policy lapses with an outstanding loan
Your ACB is the total amount of premiums you’ve contributed to your policy (minus the cost of insurance and fees). When it comes to withdrawals, any amount you take out above your ACB is taxed as income. This income tax also applies to loans that are treated as withdrawals if the policy lapses, matures, or is surrendered.
Cash value vs. death benefit
True: Cash value policies include both a cash value component and a death benefit payout.
False: Your beneficiaries receive both the cash value and the death benefit when you die.
Beneficiaries only ever receive the death benefit, as the cash value is returned to your insurance provider upon your death.
Here’s how these two features (cash value and death benefit) can play important but different roles in cash value life insurance policies:
Pros and cons of life insurance with cash value
Cash value life insurance sounds good on paper, but there are a few downsides worth noting. Here’s what you should know before moving forward:
Cash value life insurance pros
Cash value life insurance cons
Is cash value life insurance worth it?
Cash value life insurance typically isn’t worth it for the average Canadian family. These types of policies are expensive, complicated, and rarely the best option for building wealth.
The “insurance plus an investment” aspect of cash value life insurance may seem like a two-in-one deal, but investment vehicles like RRSPs, TFSAs and RESPs offer much higher returns, and they don’t pose the costs of permanent policies.
And yes, some policies allow borrowing against your cash value, but you’ll have to pay interest on the loan. Borrowing can also work against the core purpose of life insurance if you don’t pay the loan back. Your death benefit will decrease, leaving your loved ones with a lower payout.
“[It is] the worst thing you can do … you’ll have to pay interest on the loan, and if you don’t pay all of it back, your death benefit will decrease. Think about how crazy this is – you’re paying interest on a loan made up of your own money.”– Dave Ramsey, Personal Finance Expert
Cash value policies also have a learning curve. You’ll need to understand complicated rules, added fees, and how the investment works, on top of paying higher premiums. A simpler term life policy can be easier to manage and offer the same coverage as a permanent policy, but at a much cheaper rate.
When does cash value life insurance make sense?
Cash value life insurance has its upsides, so it might make sense depending on your situation. Here are a few policyholder profiles that may align with a permanent policy that includes cash value:
- High-net-worth individuals: Cash value grows tax-deferred, so it may serve as another tax-sheltered investment if you’ve already maxed out your RRSPs, TFSAs and other traditional funds. Permanent life insurance can also support estate planning by providing a guaranteed death benefit, which can be especially beneficial if you’ll leave behind a large estate.
- Business owners: Permanent policies typically offer tax or estate planning perks for business owners who want to protect their company’s future. The business can borrow against the policy’s cash value and build the asset on a tax-deferred basis, while the death benefit safeguards the business.
Individuals with lifelong dependents, such as a family member with a disability, may also benefit from a permanent policy. But permanent policies that include a cash value component are complex, expensive and often unnecessary in these cases. If this sounds like your situation, consider a permanent life insurance plan that doesn’t include cash value, as they are typically way more affordable.
Alternatives to life insurance with cash value
Better alternatives to cash value policies include term insurance and registered savings accounts. The right solution depends on whether your goal is income replacement, liquid savings, investment growth, or pure insurance.
Term life insurance is best for income replacement and pure insurance. It provides the highest death benefit (income replacement) per dollar for a set period. There’s no confusing savings component, and you protect your family’s financial future for less. Best choices for most Canadians.
TFSA (Tax-Free Savings Account) is best for flexible savings. Your contributions grow tax-free, and your withdrawals are tax-free. You can invest money here, and this money is yours at all times.
RRSP (Registered Retirement Savings Plan) is best for long-term retirement investing. Invest in the stock market while you’re in a higher tax bracket during your peak earning years. You’ll likely earn higher returns here than with a cash value policy, and then you can make withdrawals when you’re in a lower tax bracket in retirement.
High-interest savings account (HISA) is best for emergency savings and short-term cash access. Your money is available to you at any time and it grows at a steady rate, with no insurance component or complicated investments.
Bottom line: If you want insurance, buy insurance. If you want to grow your cash, then use financial accounts designed for that purpose.
Term life insurance vs. cash value life insurance
Term life insurance offers coverage for a specific time period (typically between 10 and 30 years) and doesn’t include a cash value component. Due to its simplicity, term life coverage is usually much cheaper than whole life or universal life policies.
On top of its lower price point, term coverage is a popular option for Canadians because it aligns with the temporary financial needs of most people, and ends when those needs are settled.
For example, many policyholders take out a term policy when they have young dependent children or a new mortgage. By the time the term is done, their children are financially independent and their mortgage is nearly or fully paid off.
The biggest differences between term life and permanent life policies are the coverage periods, structure, and cost, but there are other aspects that set them apart. Here’s a side-by-side comparison:
In short, term life insurance balances affordability and protection. Lower term life premiums give you the option to invest your savings into smarter wealth-building vehicles, where you’re likely to see better returns compared to cash value growth.
PolicyMe offers some of the best term life insurance rates in Canada, with free, no-obligation quotes and an easy online application. You can review your coverage needs and explore the affordability of term life insurance in just a few clicks.
Next steps: should you get cash value life insurance?
If you answer “no” to any of the below questions, then cash-value life insurance is probably not a good fit for you:
- Am I maxing out my TFSA and RRSP every year?
- Do I want permanent insurance for estate planning, not savings access or growth?
- Can I commit to high, lifelong premiums without needing flexibility?
- Have I reviewed this with a non-salesperson?
Don’t need to build cash value but you still want peace of mind to protect your family? A term life insurance policy is an affordable and flexible way to cover your obligations while still leaving room in the budget to invest for the future.
Term coverage is often a better tool for financial security than guaranteed cash value policies, as lower life insurance premiums mean you can invest more into higher-yield investment options.
FAQ: Cash value life insurance
Bonnie Stinson is an insurance writer and researcher in Toronto with a decade of experience producing helpful, accurate content for Canadians. They have published resources for some of Canada's most innovative and consumer-trusted companies in the health, legal, and fintech sectors.
Bonnie Stinson is an insurance writer and researcher in Toronto with a decade of experience producing helpful, accurate content for Canadians. They have published resources for some of Canada's most innovative and consumer-trusted companies in the health, legal, and fintech sectors.