When you shop for life insurance, you've got two basic options: term or permanent life insurance.

Term life insurance covers you for a specific period of time, usually 10, 15, 20 or 30 years. If you live past your policy's term, there is no payout to your beneficiaries.

Permanent life insurance, such as whole life, universal life or variable universal life insurance, covers you for the duration of your lifetime. It also offers a feature that's commonly viewed as a strong selling point: cash value. In addition to lifelong insurance coverage, a portion of your premium payments goes toward a cash value account that grows tax-deferred over time.

The cash value account is one reason whole life insurance premiums are higher than premiums for term insurance. When is building up cash value worth the extra money you'll pay for the permanent life insurance policy?

Tapping into your money

Cash value grows slowly at first and generally picks up earnings speed after several years. The cash value in your policy grows each year with interest, tax-deferred. (Some policies grow cash value at a more steady rate; your insurance agent will show you illustrations of possible outcomes.)

Once you have accumulated enough cash value, you can opt to use it to cover your premium payments. This is known as being "paid up." If you decide to withdraw some cash value, you may have to resume premium payments to keep the life insurance policy in force.

Another common way people access their cash value is by taking out a loan against their policy and paying it back with interest at a rate that's generally lower than a bank loan. You're not obligated to pay it back, but the money you owe, plus interest, will be deducted from the death benefit when you die. So if you don't pay it back, your beneficiaries will lose out.

You can also make a full or partial withdrawal of your cash value. Depending on your policy and level of cash value, a withdrawal might reduce your death benefit. Exactly how much varies by policy, but in the case of universal life insurance your death benefit would be reduced on a dollar-for-dollar basis. For example, if you had a $100,000 death benefit with a $20,000 cash value and you withdrew $10,000, your resulting death benefit would be $90,000.

In some cases, partially withdrawing your cash value could decimate your death benefit. For some traditional whole life insurance policies, the death benefit could be reduced by more than the amount you withdraw.

Cash value at a glance

Let's take a look at possible scenarios of building cash value in a traditional whole life insurance policy. The below examples are from New York Life Insurance Co. Remember, illustrations will vary greatly depending on the insurer, the policy face amount, the policy type and your rating classification (preferred plus, preferred, standard, etc.).

Below are illustrations of how much cash value a 35-year-old nonsmoking male with a preferred-rate $100,000 whole life insurance policy could build up over his lifetime. Policy values and benefits shown are based on a dividend scale that is not guaranteed and could be more or less than those shown.

The first set shows what could happen to the cash value and death benefit if he taps his cash value to pay premiums. The second set shows what could happen if he pays his premiums himself every year.

Continue on to Page 2