There’s a comfort to knowing that you can tap into your permanent life insurance policy’s cash value should you ever need to. But, borrowing or taking out cash from your policy comes with some risks.
Face Value vs. Cash Value
When you pay your whole or universal life insurance premium, a portion goes toward the amount your beneficiaries will be paid when you die. This is the face value. A portion of your premium payment also goes toward the policy’s cash value. This value grows over time as it earns interest.
Your policy’s cash value is what you have access to should you decide to withdraw or borrow cash from the policy.
Why Cash In?
For many, cash value is a way to get hold of money should they need it. This could be a child’s college tuition, a down payment, or an unexpected emergency.
Why Not Cash In?
The consequences of cashing in on your life insurance during your lifetime need to be considered before making a decision to withdraw or borrow from your policy.
Taking a loan from or withdrawing a portion of the cash value:
- May reduce the death benefit
- May ultimately result in a tax liability, should you let your policy payments lapse
Ways to Tap Into the Cash Value
Besides considering these drawbacks, you need to weigh the pros and cons of the method you use to access the cash value.
You can usually borrow from the cash value. Since you’re getting a loan of your own money, it’s not taxable income. This can be a welcome alternative to getting a credit card cash advance, getting a payday loan, or taking out a standard bank loan, especially since a loan from your life insurance cash value doesn’t affect your credit score. With a policy cash value loan, you’re not required to pay it back. You can always start paying it back when you are in a better position to do so, but because repayment is required, you’re more likely to never pay it back. In the meantime, the interest on the money you borrowed continues to accrue, paring down your death benefit.
In most cases you can withdraw up to what you’ve paid into the cash value to that point, tax free. If you need to borrow above what you’ve paid, that portion will be considered taxable income.
- Let Cash Value Pay Your Premiums
When things are tough financially, you can probably quit paying premiums and let the cash value in the policy cover them instead. Just don’t lose track and deplete the funds, letting your policy lapse. A lapsed policy means you will no longer have life insurance coverage.
Some choose to cancel a policy, even though that means they won’t be covered any more. If you go this route, you’ll get the cash value less unpaid premiums or money already removed through a loan.
You may be able to sell your policy to a settlement broker or provider. The broker will seek out competitive bids on your behalf. When you sell to a provider, you cut out the middleman. Life Insurance Settlement Association (LISA) provides some good information about brokers and providers.
Before You Decide
Accessing cash value on a permanent life insurance policy can sometimes save the day, but it can come with a many drawbacks. There are a lot of details to consider, and every individual’s situation is different. Be sure to speak with your agent before you decide the best way to move forward.
To learn more about the different kinds of life insurance, read our article What’s the Difference: Term, Whole and Universal Life Insurance.