Life Insurance: Cashing In While Still Alive?

Life insurance is often thought of as something that can only benefit your loved ones after you've passed away. However, depending on the type of policy you have, you may be able to cash in your life insurance policy while you're still alive. Permanent life insurance policies, such as whole life, universal life, and variable life insurance, often include a cash value component that allows policyholders to access their benefits early. On the other hand, term life insurance policies do not typically include a cash value, so policyholders cannot access their benefits until their death.

Taking a loan from your policy

Taking a loan from your life insurance policy can be a quick and easy way to get cash. Borrowing from your life insurance policy can be particularly useful if you need cash in the short term and are willing to give up long-term advantages. However, it's important to note that you can only borrow against your policy if you have a permanent policy with a cash value component, such as whole or universal life insurance. Term life policies do not qualify, as they do not have a cash value.

When you take a loan from your life insurance policy, your insurer lends you money using the cash value of your policy as collateral. This means that the policy's cash value can continue to accumulate, but it's important to understand how interest and dividends will be determined and paid. The loan is not recognised by the IRS as income, so it remains tax-free as long as the policy stays active.

Interest and Repayment

Life insurance loans typically have lower interest rates than personal loans or credit cards, ranging from 5% to 8%. There is no fixed repayment schedule, but it's important to pay back the loan as soon as possible to minimise the interest you'll owe. If you don't make regular payments, your policy could lapse, especially if the amount owed exceeds the policy's cash value.

Impact on Death Benefit

If you don't repay the loan before you die, the outstanding balance, including any interest, will be deducted from the death benefit paid to your beneficiaries. This means they will receive a lower payout.

Pros and Cons

One of the biggest advantages of borrowing from your policy is the lack of credit and tax implications. There is no credit check, and the loan does not affect your credit score. Additionally, the IRS does not recognise policy loans as income, so they are tax-free.

However, there are also disadvantages to consider. During the repayment period, your coverage amount drops, and if you die before repaying the loan, your beneficiaries will receive a reduced death benefit. Failure to repay the loan could also result in interest accumulation, potentially causing the loan balance to exceed the cash value of your policy and leading to a lapse in coverage.

The amount you can borrow depends on factors such as the cash value of your policy, how long you have had the policy, and the terms and conditions set by your insurer. Most insurers allow you to borrow up to 90% of the policy's cash value.

You can borrow from your life insurance policy once it has accumulated a substantial cash value, which generally takes several years. The timeframe depends on the terms of your policy, the premium amount, and the performance if it is linked to investments. Your insurer may also set a minimum cash value requirement for borrowing.

Withdrawing money from your cash value

Withdrawing money from the cash value of your life insurance policy is a straightforward way to access your funds. This option is usually available as soon as your policy has accrued cash value, although some companies may charge early withdrawal fees in the first few years.

The amount you can withdraw is typically limited to the cash value of your policy, or the surrender cash value (the cash value minus any fees). You can usually withdraw up to the amount you've paid in without paying income tax. However, if you withdraw more than you've paid in premiums, you will likely owe income tax on any earnings.

Before withdrawing money from your cash value, it's recommended to consult a financial advisor to understand the potential consequences of this decision and explore alternative options.

Surrendering your policy

Surrendering your life insurance policy means cancelling it and receiving a lump sum payment from your insurer. This payment is known as the cash surrender value and is the total sum in the savings component of permanent policies like whole and universal life insurance, minus any surrender fees and taxes on earnings. Surrender fees typically range from 10-35% and are usually highest in the early years of the policy.

However, it is important to note that surrendering your policy will result in the loss of coverage, and your beneficiaries will no longer receive a payout when you die. Additionally, the cash surrender value is likely to be lower than the value you would get if you sold your policy. Therefore, surrendering should be a last resort, and it is recommended to explore alternative options first.

Using cash value to pay premiums

Permanent life insurance policies, such as whole life and universal life insurance, can accumulate cash value over time. This cash value can be used to pay policy premiums, which can be useful if you're on a limited income or are struggling to make payments.

Here's how it works: when you make a premium payment for cash value life insurance, a portion of it goes into the policy's cash value, while the rest covers the insurer's cost of providing the death benefit and their fees. Over time, as you continue to make payments, the cash value builds up and can then be used to cover the cost of future premiums.

It's important to note that using the cash value to pay premiums will reduce the amount of money that your beneficiaries will receive as a death benefit. Additionally, there may be tax implications depending on the amount withdrawn and the specific regulations in your location. Therefore, it's always a good idea to consult a financial advisor before making any decisions about your life insurance policy.

Overall, while using the cash value to pay premiums can be a helpful option for those who need it, it's important to carefully consider the potential consequences and ensure that you understand the terms and conditions of your specific policy.

Using living benefits

Living benefits are riders on life insurance policies that allow you to access a portion of your death benefit while you are still alive. This is usually in circumstances where you are facing failing health, such as a terminal illness, chronic illness, or critical illness. Living benefits may be included as a term of the policy itself or added on to a term or whole life policy for an extra cost.

• Accelerated death benefits: This living benefit provides you with a portion of your term life policy if you are terminally ill. This gives you the cash to cover medical expenses, debt, and more. You can also use the funds to take a dream vacation or make other memories with your loved ones. It is important to note that different insurers have different life expectancy timelines for when you can access the cash, and the advanced amount is typically subtracted from the total amount your beneficiaries receive after your death.
• Critical illness rider: This is a variation of the accelerated death benefit option, which lets you access your death benefit if you are afflicted by a specific ailment or disease.
• Return of premium: With this living benefit, all the premiums you paid during the term are returned to you as long as you do not pass away during the term. This type of policy is typically more expensive than a traditional term life policy.
• Disability waiver of premium: This living benefit lets you skip your premium payments if you suffer a long-term disability for six months or more. While not a true cash benefit, it is still valuable as it reduces your financial burden during a difficult time.
• Cash value withdrawal: For permanent life insurance policies, you can make a withdrawal from the cash value that has accumulated over time. If the amount you withdraw is less than or equal to your premium payments, you won't owe any taxes on this withdrawal. However, you will owe taxes if you withdraw any interest, dividends, or capital gains. The amount you withdraw will be subtracted from the policy's death benefit if it is not repaid.
• Policy loan: You can take out a loan against your permanent life policy, and the interest charged is usually lower than that of other lenders. You will be charged interest on the loan, but you won't have to undergo a credit check or face a long list of restrictions. The loan amount will be deducted from the death benefit after your death.
• Policy surrender: You can cancel your permanent life policy and receive the cash value as a one-time lump sum. The insurer will deduct any outstanding loans and/or unpaid premiums from the amount paid out. Surrendering your policy will also cancel the death benefit, meaning your beneficiaries won't receive anything when you pass away.
• Long-term care benefits: Adding this benefit to your permanent life policy allows you to tap into the death benefit to cover long-term care expenses that your health insurance doesn't cover. This is especially useful considering that a large percentage of people turning 65 will need some form of long-term care in their lifetimes.

Frequently asked questions