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The primary purpose of life insurance is to pay out a sum of money to your beneficiaries after you die. But it's not the only reason to buy coverage. A recent NerdWallet study found that 23% of Americans who purchase life insurance do so to build cash value and save for retirement.

While you can use life insurance to accumulate cash value, it isn't a typical investment or the best choice for everyone. Learn how cash value works and whether this is right for you.

» MORE: Cash value life insurance: Is it right for you?

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Nerdy Tip
Life insurance is designed to provide a financial safety net to your beneficiaries. So before you consider investment options, think about whether you need life insurance to replace your income if you die.

How does life insurance work as an investment?
There are two types of life insurance: term and permanent. While both pay out death benefits, only permanent life insurance has the potential to grow a cash value.

That's because permanent policies like whole life insurance include a reserve called the “cash value.” A portion of your premium goes toward the cash value, and the money grows tax-deferred. You can withdraw or borrow against the funds to pay for expenses while alive.

Term life insurance policies don't have cash value. This type of coverage lasts for a set period, such as 20 or 30 years, and is cheaper than permanent coverage. You may hear the phrase "buy term and invest the rest" when shopping for coverage. This strategy refers to buying a term life policy and investing the additional money you would have spent on a permanent policy in something else, such as stocks. Speak to a fee-only financial advisor to see if this investment strategy is right for you.

Why should life insurance not be used as an investment?
Depending on your coverage and investment needs, life insurance may not be the best way to build wealth. Here are three essential factors to consider before using life insurance as an investment.

If you don't need the insurance component, there may be better investment options on the market. The primary purpose of life insurance is to leave a sum of money to your beneficiaries. So, if you don't require the coverage, you may want to explore other types of investments first.

The cash value doesn't pass to your heirs. Your policy's cash value is not typically added to the death benefit. It's a component of the policy that you can access while alive. Keep in mind that if you withdraw money from the cash value or take out a loan without paying it back, the death benefit is reduced by the same amount or more. 

Cost and eligibility typically depend on your age and health. You may have to take a medical exam to get coverage, which isn't necessary for other investment vehicles like a 401(k) or IRA.

» MORE: Is whole life insurance a good investment?

Using life insurance to save for retirement
If you buy a permanent policy when you're young, the cash value may grow significantly by retirement. While withdrawing cash can reduce the death benefit, you may no longer need the insurance element and would prefer to tap into the cash value instead. You can use the funds to pay for a range of expenses.

Flexible cash withdrawals. You can use the cash value in the account for any purpose and withdraw it at any time. This is not always the case with other retirement vehicles like a traditional individual retirement account or IRA, which requires you to begin taking minimum distributions in your early 70s. You may face a tax penalty for withdrawing funds from an IRA or 401(k) before reaching a certain age. In contrast, life insurance cash value doesn't have the same restrictions concerning withdrawals.

Tax-free withdrawals. You can withdraw up to the policy basis (the amount of money you've paid into the policy) without paying income tax. However, you may have to pay tax on the gains if you withdraw more than the policy basis.

Tax-free cash value loans. If you want to withdraw more than the policy basis but avoid paying tax on the gains, you can take out a loan. These loans are not taxed as income but accrue interest, which can build up over time. If the loan exceeds the total cash value, the policy can lapse. Therefore, it's recommended that you at least pay the annual interest to prevent the loan from growing. You are not required to pay the loan back. Still, if you die before repaying it, the remaining balance is typically deducted from the death benefit, leaving your life insurance beneficiaries with a smaller payout.

Important: A life insurance cash value may not be enough to support your retirement fully. Speak to a fee-only financial advisor to find a retirement plan that works best for you.

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Nerdy Tip
You don't have to qualify to take out a cash value loan. The cash is yours to borrow against when you want.

Get the most out of your cash value growth
Some insurers let you customize the speed at which the cash value grows. For example, you may be able to pay all of your premiums in a whole life policy over the first 10 years, or even all at once in a single premium, boosting the cash value growth. But keep in mind your individual premiums will be higher if you pay them over a shorter period instead of spreading them out.

Important: If you overfund your life insurance policy, it may be designated as a modified endowment contract by the IRS. If this happens, you may face additional taxes and fees for withdrawing funds from the cash value early.

You may also be able to build cash value through dividends if you choose a mutual insurance company, which is owned by policyholders. These companies typically pay yearly dividends to their whole life policyholders, which can be used to purchase paid-up additions or PUAs. These are essentially small amounts of permanent life insurance that are paid up using dividends and can increase the overall value of your investments.