Life Insurance Cash Value: Can It Decrease Over Time?

Life insurance with a cash value component is a type of permanent policy that can build funds over time. This feature is typically offered within permanent life insurance policies, such as whole life and universal life insurance. The cash value of a life insurance policy can be used for several purposes, including borrowing or withdrawing cash from it or using it to pay policy premiums. However, it's important to note that the cash value of a life insurance policy is typically not passed on to beneficiaries after the policyholder's death. Therefore, it is essential to carefully consider the implications of such a policy on your financial and estate plans before purchasing one.

Borrowing against cash value

Borrowing against the cash value of a life insurance policy can be a quick and easy way to get cash in hand when you need it. However, it is not without its risks and disadvantages. Here's what you need to know about borrowing against the cash value of your life insurance policy:

Eligibility

To be eligible to borrow against your life insurance policy, you must have a permanent life insurance policy that has accumulated a sufficient cash value. This includes whole life and universal life insurance policies, which are more expensive than term life insurance but have no predetermined expiration date. It typically takes several years for the cash value to build up to a level where you can borrow against it.

How it Works

When you borrow against your life insurance policy, you are essentially borrowing from yourself. The insurance company lends you money, using the cash value of your policy as collateral. This means that the policy's cash value can continue to accumulate, even while you have an active loan. However, it's important to understand how interest and dividends will be determined and paid during this time.

Pros

Borrowing against your life insurance policy offers several advantages. There is no approval process, credit check, or income requirements, making it a quick and easy way to access cash. The loan is also not recognised as income by the IRS, so it remains tax-free as long as the policy stays active. Additionally, there is no fixed repayment schedule, and the loan will not affect your credit score.

Cons

There are also several disadvantages to consider before borrowing against your life insurance policy. Firstly, if you do not make regular interest payments, your policy could lapse, and the entire loan amount could become taxable. Secondly, if you pass away with an outstanding loan, the loan amount and any interest owed will be deducted from the death benefit, reducing the amount your beneficiaries receive. Finally, failure to repay the loan could deplete the cash value of your policy, affecting the guarantees and benefits associated with it.

Alternatives

If you are considering borrowing against your life insurance policy, it's important to weigh your options and understand the alternatives. You may be able to make a withdrawal from your policy, use the cash value to cover your premiums, or surrender your policy for its cash value. Each option has its own pros and cons, so be sure to consult a financial advisor to understand the potential consequences of each choice.

Withdrawing cash value

Firstly, withdrawing cash from your life insurance policy will reduce the death benefit. This means that your beneficiaries will receive less money when you pass away. Therefore, it is essential to carefully consider the impact of a withdrawal on your loved ones before making any decisions.

Secondly, while withdrawals up to the amount you have paid in premiums are typically not taxable, withdrawals that exceed this amount may be subject to income tax. It is important to understand the tax implications of your withdrawal to avoid any unexpected costs.

Thirdly, there may be fees or penalties associated with withdrawing cash from your life insurance policy. For example, if you withdraw money during the first few years of the policy, you may be subject to early withdrawal fees. Additionally, if your policy has been classified as a Modified Endowment Contract (MEC), withdrawals may be taxed differently and could be subject to an early withdrawal penalty if you are under a certain age.

Finally, it is important to remember that withdrawing cash from your life insurance policy should not be taken lightly. While it can be a useful source of funds in certain situations, it may not always be the best option. It is recommended to consider alternative sources of funds, such as personal loans, home equity loans, or borrowing from your retirement account, before withdrawing from your life insurance policy. Consulting a financial advisor can help you understand the potential consequences of accessing your cash value and make an informed decision.

Surrendering policy for cash value

Surrendering your life insurance policy means cancelling it and receiving a cash payment. This payment may be a lump sum or paid over time.

The cash surrender value is the amount of money that a life insurance company pays out to a policyholder if they decide to cancel the plan. This is the savings component of most permanent life insurance policies, such as whole life and universal life. It is also known as the policyholder's equity.

The cash surrender value is the amount of cash you've built up minus any surrender charges or fees. These charges diminish over time, so the longer you've had your account, the closer the cash surrender value will be to the cash value.

In the early years of a policy, life insurance companies can deduct fees upon cash surrender. What you receive for your cash surrender value could be less than your current cash value balance after subtracting these fees. The surrender charge can start as high as 10% to 35% of your policy cash value. If your policy has a surrender charge, it will go down over time and usually ends after 10 to 15 years. At this point, your cash surrender value equals your cash value.

If you surrender your policy, you end your life insurance contract. You stop paying premiums and will receive all your cash surrender value. However, you lose your life insurance protection and your heirs will no longer receive a death benefit when you pass away.

If you surrender your life insurance policy, you may owe fees and other charges. Therefore, the surrender value could be less than your current cash value. In addition, if you surrender your life insurance policy, it will impact your listed beneficiaries as you will no longer have insurance protection.

Before surrendering your policy, consider the alternatives:

• Withdrawal: In most situations, you can take a cash withdrawal from your permanent life policy, and that money will not be subject to income taxes if it's less than the amount paid into the policy. However, your death benefit will likely be reduced, and this reduction may be greater than the amount withdrawn, depending on the specific terms of your policy.
• Loans: You can typically borrow money against your policy, although the amount varies. The money does not come from your policy but from the insurer who uses your policy as collateral. Life insurance loans include interest payments, but it's typically a lower rate than you'd get with personal loans or a home equity loan. No loan application or credit check is required, and your credit rating does not impact your interest rate. You can choose not to repay, but the outstanding loan balance will typically be deducted from your death benefit.
• Use cash value to pay your life insurance premiums: You can typically use the money in your cash value to pay part or all of your policy premiums, making it easier to keep your coverage in place. This is a popular option for older policyholders who want to use retirement income for living expenses but still want to keep life insurance coverage in place. However, if the policy's cash value becomes too low, your policy may lapse.

Using cash value to pay premiums

If you have a permanent life insurance policy, you can use the cash value that has built up in your policy to pay your premiums. This can be helpful if you need to reduce your monthly expenses but want to keep your policy in place. However, it is important to note that any amount taken from your cash value account to pay premiums will reduce the death benefit paid to your beneficiary.

The ability to use cash value to pay premiums is typically offered by variable and universal life insurance policies. These policies allow you to use the policy's cash value to pay premiums, which can help keep your coverage in place for years at little to no additional cost. However, it is important to carefully monitor the cash value to ensure it doesn't drop too low, as this could result in a loss of coverage.

Whole life insurance policies usually do not let you pay premiums using the policy's cash value, except if you convert to a paid-up policy. Not all insurers offer this option, but with a paid-up life insurance policy, the cash value is large enough that you can stop paying premiums out of pocket. However, the downside is that each premium payment is deducted from the policy's death benefit, and less cash value is available for other purposes, such as a policy loan.

When deciding whether to use cash value to pay premiums, it is important to consider the potential impact on your death benefit and the long-term sustainability of your coverage. Consulting a financial advisor can help you understand the consequences of accessing your cash value and how it fits into your overall financial plan.

Using cash value to increase death benefit

Permanent life insurance policies like whole life and universal life insurance offer a cash value component. This is a savings account-like feature that accumulates cash value over time. The cash value of a life insurance policy is the total amount of premiums paid minus the cost of insurance and other charges assessed by the carrier.

The cash value of a permanent life insurance policy can be used to increase the death benefit. Here's how:

Understand the Trade-Off Between Death Benefit and Cash Value

The death benefit and cash value are both tied to your premium payments. A higher premium payment will result in a larger death benefit and faster-growing cash value. When designing your policy, you can prioritize one over the other. If you anticipate the need for a larger death benefit payout, you can structure your policy accordingly.

Explore Riders to Add Cash Value to the Death Benefit

Some policies include a rider that adds the cash value to the death benefit, resulting in a larger payout for your beneficiaries. However, insurance carriers charge significantly higher premiums for this feature.

Consider Whole Life Insurance

Whole life insurance offers a fixed premium, a fixed rate of growth for cash value, and a guaranteed death benefit amount. Due to these guarantees, whole life insurance is typically more expensive than other options. The cash value in a whole life policy can be used to increase the death benefit, but it may require additional premiums.

Weigh the Costs and Benefits

While increasing the death benefit through cash value can provide greater financial security for your loved ones, it comes at a cost. Higher premiums and careful management of the cash value are necessary to ensure the policy remains in force. Additionally, any withdrawals or loans from the cash value will reduce the future death benefit.

In summary, the cash value of a permanent life insurance policy can be used to increase the death benefit, but it requires careful planning and may result in higher costs. It's important to weigh the benefits against the potential drawbacks and consult with a financial advisor to determine the best option for your specific situation.

Frequently asked questions