Many people know that life insurance can provide protection from the financial risk of an early death, but fewer people realize that life insurance can actually simultaneously be an excellent investment as well.  During a policy owners life, a life insurance policy can accrue a very large cash value.  The cash value can be used for withdrawals to pay for expenses, loans can be taken against it, and it can increase dividend payments and the rate of return for the policy.

Permanent Forms Of Insurance Have A Cash Surrender Value

Every permanent form of life insurance carries a cash value.  This generally will increase over time if the policy is funded as illustrated and performs somewhat closely at least minimum expectations.  Permanent forms of life insurance with cash value include whole life insurance, universal life, and variable universal life policies.

Term insurance does not have a cash value, and “permanent term” which is usually renewing term to age 100 or older, also does not contain any cash surrender value.

Cash value can be accessed at any time, and for any reason.  Many high net worth individuals invest in permanent life insurance solely for the cash value benefit.

Cash Value Provides A Rate Of Return

Cash value is not merely a “sock drawer account” that is a stagnant store of money.  The cash value of every life insurance policy is meant to be able to provide a positive rate of return for the owner over time.  This return on investment is achieved through different means for each type of insurance.  Of course cash value grows through payments made into the policy, but this section is primarily concerned with the way the cash value grows internally for each type of life insurance.

Whole Life Insurance

Guaranteed Growth

Whole life insurance cash value increases through payments made into the policy.   A portion of every premium payment goes into the cash value account, which is a savings repository within the policy.  The cash value in a policy is then guaranteed to grow at some minimum rate, stated when the policy is issued in the initial illustration.  This minimum rate usually will provide a positive rate of return for the policy owner over time, meaning that the cash value will at some point be worth more than the total amount of premiums paid into the policy.

All cash value growth within a life insurance policy is tax deferred, making this more and more advantageous as people pay higher income tax rates.  The compounding tax deferred growth within a life insurance policy can make the true after tax return pretty attractive compared to other investments, especially taking into account how stable (secure and not volatile) a whole life insurance policy is.

Whole life insurance is considered an extremely safe investment because life insurance companies are mandated to meet certain reserve requirements by law.  This means that their financial structure lends to them being some of the most financially sound companies in the history of United States corporations.  For evidence many of the large life insurance companies have not only been in business since the 1800s, but they have made dividend payments for over a hundred consecutive years (even through the great depression).


In addition to the guaranteed rate of growth, the component that really hastens the growth of the cash value account investment is dividend payments from the life insurance company to the policy owner.  Typically, the dividend amount will increase as the policy ages and as the cash value grows.  Larger death benefit policies are paid higher dividends as well.  Dividends are paid at the end of the year, after the company has calculated their financial results.  Dividend payments are improved through a lower experienced death rate than expected, higher company sales, and the general interest rate environment.

Whole life policy owners have three options when it comes to using their dividend payments.  The payments can be used to:

  1. Be paid directly to the owner of the policy as a check.
  2. Reduce premiums.
  3. Purchase additional paid up insurance, increasing the death benefit and the amount of future dividend payments.

All three of these options increase the rate of return experienced by the policy owner.  The effects of each of these options and the reasons policy owners choose each option are as follows:

Direct Payment Of Dividend To Owner

A dividend payment received as a check is direct income for the owner.  This income is considered taxable by the IRS, and this is not the most efficient use for dividend payments as far a achieving the highest long term rate of growth.   However, this is not always the goal of every life insurance policy used for investment purposes.

Some life insurance owners fund life insurance policies with the intent that the policy will provide them payments to supplement their retirement income.  By taking the dividends as cash, the owner can get a payout every year for the rest of his/her life.  No one would invest in life insurance solely for the cash dividend payment, but the dividend income payments coupled with the death benefit paid when a death claim is filed is an attractive combination.

Policy owners can even take withdrawals from the cash value late in the policies life, and still have enough value to keep the policy in force for the entire life of the insured.  When the total return of the policy is calculated using both the death benefit and dividend payments (and especially when coupled with the early access to money through withdrawals) it becomes a net positive for total money paid from the policy.

Using Dividends To Reduce Premiums

By using dividend payments to reduce premiums, the amount of money that the policy owner pays into the policy is reduced.  Even though the owner is paying less and less money over time, the cash value is still guaranteed to grow by the illustrated minimums.  After enough time, the dividend payment may be able to pay the entire policy premium all by itself.  At this point the life insurance policy will continue to accrue cash value without any more money being paid in.

After many years, the policy value will increase substantially.  When dividend payments are larger than the premium payment, the excess can be used to either purchase paid up insurance or can be paid out directly to the owner.  Purchasing paid up insurance in term increases the dividend payments even further in future years.  When the owner compares the amount of cash value accrued and the amount of money that has been withdrawn from the value of the policy, to the amount that was actually funded into the policy, the rate of return can lend to the investment being viewed as a pretty attractive instrument.   Don’t forget that the whole time life insurance coverage is also in place protecting beneficiaries and increasing the size of the estate paid to the next generations.

Using Dividends To Purchase Additional Paid Up Life Insurance

Using this method of dividend usage for the first stages of a life policy leads to the highest rate of return in most cases.  Paid up insurance adds to the death benefit of the policy, without adding any additional premium due each year.  Paid up insurance (and the corresponding higher face value of the contract) also leads to higher dividend payouts in subsequent years.  Each year the dividend payment grows and the insurance coverage and cash value grows along with it.  The paid up life insurance also creates a corresponding cash value increase. At some point these dividend payments can be directed to pay the premium, and the excess can be sent to the owner as a check.  The cash value, growing tax deferred the whole time, can be withdrawn from the policy as well, with the cost basis withdrawn first.  Even with withdrawals the policy may have enough cash value to remain active, and still pay a death benefit as well.

The bottom line is that through cash value guarantees and dividend payments, a whole life insurance policy has a bigger benefit than just the death benefit.  It benefits the owner during his lifetime with the positive internal rate of return and tax advantages.  With payments from dividend and the cash value growth, whole life insurance is a valuable investment vehicle.

Universal Life Insurance

Universal life insurance pays a guaranteed minimum rate of return (2% by law) or higher when prevailing interest rates are higher.  The interest rate is determined through a published formula usually tied to other rates such as LIBOR.  Each month a cost of insurance charge comes from the cash value.  The universal life policy allows flexible premium funding, however, which is unlike a whole life insurance policy.

The way to generate a positive rate of return with a universal life insurance policy is to fund the policy well in excess of the cost of insurance.  The excess continues to accrue in the cash value account, which is then paid the current interest rate.  This value also accrues completely tax deferred, which increases the true rate of return.  The higher the tax bracket of the owner, the higher the true net rate of return provided by the policy.  Eventually with enough cash value the policy can become self sustaining and can continue to grow  without further payments being made.  This both keeps the life insurance in force and provides a source of savings for the owner.

Universal life insurance enjoys the same tax advantages a a whole life insurance policy.  All growth is completely tax deferred and withdrawals are taken FIFO, meaning the entire amount that was paid into the policy can be withdrawn tax free.  With enough cash value an owner could potentially remove his entire investment and still leave enough cash value in the policy to continue growing.  Loans can also be taken tax free and used as a source of income.

Variable Life Insurance Has An Unpredictable Return, But Highest Potential

Variable universal life insurance works similarly to universal life insurance in that the premium payment structure is flexible.  As long as the cost of insurance charges are covered, it does not matter if a person is paying into the policy or not.  Any excess premium payment over the cost of insurance is deposited into the cash value account.

Cash Value Invested Into Variable Sub Account Funds

The cash value account in a variable universal life insurance contract does not always carry any guaranteed rate of return, though some contracts may provide this.  The cash value account is invested into funds effectively the same as mutual funds, called sub accounts.  Each sub account is managed and invests in different securities according to the investment object of each.  For instance some may focus on high yield bonds, or mid cap equities, or utilities.  Others may be funds whose performance is tied to indexes such as the S&P 500.  The client has full control over which subaccount to invest in, and can make trades similar to mutual fund trades in a brokerage account.

The cash value then fluctuates daily according to the market performance of each subaccount.  The more money that is invested into the cash value account over the cost of insurance, the more money (higher relationship of market value to insurance cost) that can be invested into the market and earn more money.

This value grows tax deferred just like other forms of life insurance, even though it is invested into the market.  The death benefit of course provides protection for beneficiaries the entire time, and withdrawals are taxed with the tax free cost basis being removed from the policy first.

If the investments within a variable life insurance policy are performing highly, the returns on this type of life insurance will rival investment accounts.  Because these are tax deferred as well, the net return can become even higher.

The risks are that investments perform poorly.  The cost of insurance within a universal life insurance policy and a variable universal life insurance article rise over time.  If the investments perform poorly on top of this, clients can end up spending a lot of money on a variable universal life insurance policy with little return until a death claim is filed.  Sometimes these policies become difficult to keep in force until death because the cost of insurance is so high.  The worst case scenario for a policy owner is to pay a lot of money into the policy for years, and then have the policy lapse with no value.  Just like with investment accounts, sound investing strategies with diversification of risk is required to give a policy the highest chance of performing well over time.

Loans can also be taken tax free from a variable policy, which are a great way to access large sums of cash value free of tax.

Life Insurance Is An Investment For Owners And Beneficiaries Sake

No matter the form of life insurance used, life insurance is a great way to pass on money tax free to the next generation.  Even if the policy does not provide extra money for the owner, it will provide a wonderful benefit to the beneficiaries.  The tax deferred earnings in life insurance makes the rate of return higher than the equivalent amount if the money was not tax deferred, and the entire investment can be withdrawn tax free.

Life insurance is a great way to diversify an investment portfolio and whole life insurance is an attractive alternative to other forms of fixed income investment, even without considering the death benefit provided.

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