Life insurance can provide much-needed money for the loved ones you leave behind when you die. That financial safety net for those who depend on you for support is the main reason to buy a policy.
But life insurance can also provide you with cash while you live, that is, if you have a cash value life insurance policy. this is one of the advantages of a permanent policy and a key reason why it costs more than a term life insurance policy (plus it lasts a lifetime).
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You can access cash in several ways. that’s right: it’s yours for the taking. however, before you do this, understand your options and the pros and cons of each.
what is cash value?
When you buy a cash value life insurance policy, the premium you pay doesn’t just go towards the death benefit – the amount paid to your beneficiaries when you die. it also goes to a cash value account and internal policy costs.
The cash value of a life insurance policy grows at a fixed or variable rate, depending on the type of policy you have. A whole life insurance policy will have a fixed interest rate and generally pays dividends that will help the cash value grow. Universal life insurance often has variable rates, so cash value growth will depend on investment performance.
cash value grows tax-deferred. You can even get cash out of a policy tax free if you use the right cash access strategy.
withdraw the cash you need
Because the cash in permanent life insurance is yours, you can withdraw it whenever you want. just call your insurance company to tell them how much you want to withdraw, and they’ll wire the cash or deposit it into your bank account, says Josh Hargrove, a certified financial planner with Insight Wealth Partners in Plano, Texas.
Withdrawals are first taken from your “basis” – the amount you have paid in cash value through premiums. That money comes out tax-free because it’s considered a return on your basis. For example, if you have $50,000 in cash value and $30,000 of that amount is your basis, you could withdraw $30,000 tax-free. However, if you touch the earnings portion, you’ll have to pay taxes on the earnings at your regular income tax rate, Hargrove says.
Withdrawing cash for a life insurance policy will also reduce the death benefit. That means your beneficiaries will get less when you die, which is something you should consider before taking cash out of a policy.
pros and cons of cash withdrawal
- pros: no interest is paid on a withdrawal.
- cons: A withdrawal reduces the cash value of your policy and the death benefit. may be taxed if the withdrawal exceeds the amount of premiums paid.
- pros: No loan application or credit check. you can pay back the loan at your own pace and the money goes back to your policy instead of a lender. you can get positive arbitrage on the money you borrow.
- Cons: Interest rate may be higher than other options. the loan will be subtracted from the death benefit if you don’t pay it back.
- pros: If the policy has a surrender or cash value greater than the surrender charge, that’s money in your pocket.
- Cons: Potential surrender charges may wipe out any cash value. you may have to pay taxes. your heirs will not receive a death benefit.
- advantages: You will get more cash than you would when you canceled your policy.
- cons: There are restrictions to qualify for a life settlement. the cash offer will be much less than the policy’s death benefit.
borrow the cash you need
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Instead of withdrawing cash from your policy, you can borrow it.
A life insurance policy loan can be a quick and easy way to get cash for a purchase like a car, for retirement income, or to help cover costs temporarily if you lose a job.
“Loans are the most common way policy owners access the cash in a policy because they are completely tax-free,” says chris abrams, founder of abrams insurance solutions in san diego (as long as you don’t borrow from a modified endowment contract).
Also, you don’t have to repay the amount you borrow. but if you don’t pay it back, the amount will be deducted from the death benefit paid to beneficiaries.
However, like any loan, there is a fee for borrowing. so the amount due will increase over time due to interest charges.
The benefit of a participating loan is that you can continue to earn interest on the outstanding amount of the loan. For example, if the interest rate on the loan is, say, 5% and your cash value return is 7%, you’d still earn 2% of the amount you borrowed, says Abrams. On the other hand, if the rate of return fell to 0% in a falling market, you would have to pay the full 5% interest rate on the loan.
When borrowing your cash value, you should be careful not to borrow too much. If the loan amount plus interest due reaches the full cash value of the policy, the policy may lapse.
pros and cons of the policy loan
deliver the policy for cash
You can surrender your policy in full for full cash value, less any surrender charges. and you will have to pay taxes on any gains made on the cash value portion of the policy. plus, you’ll give up your life insurance coverage because surrendering a policy cancels it.
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“Waiving up a policy is always the absolute last resort,” Abrams says. If you’re considering dropping your policy because you’re having trouble paying your premiums, you have other options if you can’t pay your life insurance bill.
For example, you could reduce the policy’s face value to lower your premium, or use the cash value to convert the policy to paid-up status to keep a certain amount of coverage in force. You can also tap into your policy’s cash value to pay your life insurance premiums temporarily if you’re having a hard time. if you do this, be careful not to spend so much cash value that your policy lapses.
pros and cons of policy delivery
sell your policy for cash
You can get more than the cash value of your policy by selling it to a third party through a process called life settlement. the third party will pay you a lump sum that is less than the policy’s death benefit, but more than the cash value. the buyer will then pay the premiums for the policy. when he dies, the investor collects the death benefit.
You might consider a life settlement if you have an immediate need for cash that outweighs the need for life insurance.
You must be a certain age, usually 65, or have a certain level of health problems to qualify for a life settlement. The older you get, the more likely you are to sell your policy, says Lucas Siegel, executive director of Harbor Life Settlements.
You can be under 65 to sell a life insurance policy through a life settlement, but you usually have to be very sick. “Life settlements are calculated by understanding your life expectancy, and most outside buyers prefer to buy policies with a life expectancy of 10 years or less,” he says.
Being highly qualified by age and health condition will also help you get a higher payout. work with reputable life settlement companies and get offers from more than one company.
Note that there may be fees associated with life settlements, and you’ll pay income taxes on the amount you receive from the sale of the policy.
pros and cons of life agreements
see other options
Before choosing any of these options for using cash on your life insurance, talk to your insurance agent or financial advisor. discuss how your policy will be affected by each option. Also, consider whether there are better alternatives to getting the cash you need instead of using your cash value. If you bought the policy to provide a financial safety net for your loved ones after your death, you don’t want to jeopardize it by stealing your policy with cash.
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