Unlocking Cash Value Life Insurance: Strategies For Success

Cash value life insurance is a type of permanent life insurance that includes a cash value feature. This means that, as well as providing a death benefit, the policy also acts as a savings/investment vehicle. The cash value of a life insurance policy is based on the premiums paid, the length of time the policy has been active, and the size of the death benefit. The cash value can be accessed in several ways, including withdrawals, loans, and full surrenders, and can be used for various purposes, such as funding retirement, paying for a child's education, or buying a home. While cash value life insurance can provide valuable financial flexibility, it is important to consider the potential drawbacks, such as higher premiums and the time it takes to build up cash value.

Borrowing against cash value life insurance

The cash value of a permanent life insurance policy is the portion of the policy that accumulates over time and can be withdrawn or borrowed against for long-term savings needs. This cash value can be used to cover significant expenses, such as a down payment on a home, paying for a child's college costs, or covering an unforeseen emergency. It can also be used to supplement retirement income, as the cash value can be accessed at any time via policy loans.

When borrowing against a life insurance policy, there is no approval process or credit check, and the money can be used for anything without restriction. The loan is also generally tax-free, as long as the policy stays active. However, it is important to note that the loan will accrue interest, and if left unpaid, it will reduce the death benefit and may cause the policy to lapse. Therefore, it is crucial to pay back the loan in a timely manner, in addition to regular premium payments, to avoid any negative consequences.

Before borrowing against a life insurance policy, it is essential to consider the potential risks involved, such as reducing the death benefit and tampering with the guarantee of the policy. It is also important to consult with a financial advisor to understand the tax implications and ensure that the policy is structured properly to allow for loans.

Withdrawing cash from the policy

Withdrawing cash from a cash value life insurance policy can be done in a few different ways, each with its own pros and cons. Here is an overview of the methods for withdrawing cash from the policy:

Withdrawals

Many policies allow you to make withdrawals from your cash value. Withdrawals are often tax-free up to the amount of your "basis" or "cost basis", which is the total of the premiums you have paid minus any previous withdrawals and dividends received. Withdrawing more than this amount may be subject to income tax. Withdrawals will generally reduce the death benefit of the policy and may also cause an increase in premiums to maintain the same death benefit.

Loans

You can borrow money from your cash value, using the policy as collateral. Loans are generally provided at lower interest rates than bank loans, and there is no loan application or credit check required. You are not obligated to repay the loan, but if you don't, the outstanding loan balance and interest will be deducted from the death benefit paid to beneficiaries. Borrowing from your cash value can also cause a reduction in the death benefit and may cause the policy to lapse if insufficient premiums are paid.

Surrendering the Policy

You can choose to surrender or cancel your policy and receive the full cash value, minus any surrender fees. This will terminate the policy and you will lose your life insurance coverage. Surrendering the policy may also result in tax liabilities on any gains made on the cash value.

Selling the Policy

If you meet certain age or health criteria, you can sell your life insurance policy to a third party through a life settlement. The third party will pay you a lump sum that is greater than the cash value but less than the death benefit. They will then take over premium payments and receive the death benefit when you die. This option usually provides more cash than surrendering the policy but has additional costs, such as fees and commissions, which can reduce the net amount received.

Cashing out your policy

If you have a permanent life insurance policy that has accumulated cash value, then yes, you can take cash out before your death. There are three main ways to do this: loans, withdrawals, and surrender.

Loans

You can borrow money through your policy, although the amount varies. The money does not actually come from your policy but from the insurer who then 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. There's no loan application or credit check, and your credit rating is not impacted by your interest rate. You can choose not to repay the loan, but the outstanding balance will typically be deducted from your death benefit.

Withdrawals

In many situations, you can take a cash withdrawal from your permanent life policy, and that money is often not subject to income taxes as long as it's not more than the amount you've paid into the policy. However, your death benefit will likely be reduced, depending on the value of your cash account, and that reduction may be greater than the amount withdrawn, depending on the specific terms of your policy.

Surrender

You can surrender your life insurance policy entirely to get the full cash value, minus any surrender charge. And you'll have to pay taxes on any gains earned on the cash value portion of the policy. Plus, you'll be giving up your life insurance coverage because surrendering a policy terminates it.

Using cash value to pay premiums

If you have a cash value life insurance policy, you can use the cash value to pay your premiums. This strategy is often used with variable and universal life insurance policies, as they allow the policy's cash value to be used to pay premiums. However, it is important to carefully monitor the cash value to ensure it doesn't drop too far, as you may lose your coverage.

With whole life insurance policies, you typically cannot 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, 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 using the cash value to pay premiums, it will only work for a short period if you start while the cash value is small or if interest rates are low. For example, if your annual premium is $5,000 and you have $100,000 in cash value, you would need the policy's cash value to net 2.5% interest annually to cut your premium payments in half while maintaining the full cash value.

It's important to note that the older you are, the more likely it is that the cost of your premiums will outweigh any eventual benefit. Therefore, a cash value life insurance policy may not be recommended if you're advanced in years.

Tax advantages of cash value life insurance

Cash value life insurance is a type of permanent life insurance that includes a cash value feature. The cash value is the portion of your policy that accumulates over time and can be withdrawn or borrowed to cover significant expenses. There are several tax advantages to cash value life insurance.

Tax-Free Death Benefits

Life insurance death benefit payouts are usually not taxable, meaning beneficiaries receive the money without a tax burden. However, if a beneficiary chooses to delay the payout or take the payout in instalments, interest may accrue, which may be taxed.

Tax-Deferred Cash Accumulation

The cash value of your life insurance policy will not be taxed while it's growing. This is known as "tax-deferred", allowing your money to grow faster as it's not reduced by annual taxes. This means the interest you make on your cash value is applied to a higher amount.

Tax-Free Withdrawals and Surrenders

Withdrawals and surrenders are usually income tax-free. However, withdrawals that exceed your policy basis may be subject to taxation. The policy basis is the total of all the premiums paid minus any previous withdrawals and dividends received.

Modified Endowment Contracts (MECs)

If your payments exceed Internal Revenue Code limits, your contract becomes an MEC. While many people prefer to avoid MEC status, the cash value continues to grow tax-deferred. This may appeal to those who want life insurance coverage but don't expect to access the value during their lifetime.

Tax-Free Loans

Loans taken out against the cash value of your life insurance policy are generally not treated as taxable income. However, they will have interest charged by the insurance company, and this will reduce the amount paid to your beneficiary when you die.

Frequently asked questions