Maximizing Cash Value Life Insurance: Strategies For Success

Cash value life insurance is a feature offered within permanent life insurance policies, such as whole life, universal life and variable life insurance. It allows you to use the cash value as an investment-like savings account, providing lifelong coverage combined with an investment account. When the insured person dies, a death benefit is paid to the beneficiaries, as long as the premiums have been paid. However, it's important to note that the cash value is separate from the death benefit, so your beneficiaries will not receive the cash value when you pass away. This guide will explore the different ways to utilise the cash value of a life insurance policy.

Use it to pay premiums or the cost of insurance

Cash value life insurance policies are a form of permanent life insurance that lasts for the lifetime of the holder and features a cash value savings component. The cash value of a life insurance policy is separate from the death benefit, so your beneficiaries will not receive the cash value when you pass away.

The cash value of life insurance can be used to pay policy premiums. If there is a sufficient amount, a policyholder can stop paying premiums out of pocket and have the cash value account cover the payment. However, this will only work for a short period if you start when the cash value is small or if interest rates are low.

Whole life insurance policies typically don't 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. Instead, you can use the cash value to pay premiums. The downside to paid-up whole life insurance policies is that each premium payment is deducted from the policy's death benefit. In addition, less cash value is available for other purposes, such as a policy loan.

Variable and universal life insurance policies are often favoured because they allow you to use the policy's cash value to pay premiums. If you have a fairly large cash value with consistent returns, you can keep coverage in place for years at little to no additional cost.

For example, if your annual premium is $5,000 and you have $100,000 in cash value, you would just 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 carefully monitor the cash value to make sure it doesn't drop too far, or you may lose your coverage.

Make partial withdrawals

Making a partial withdrawal from your cash value life insurance policy is a simple process, but there are some important considerations to keep in mind. Here are the key points to understand about making partial withdrawals:

• Availability of Funds: Withdrawing money from your cash value life insurance policy is usually possible, but the amount available differs based on the type of policy and the insurance company. In most cases, you can withdraw up to a set limit, which is typically the amount you have contributed in premiums.
• Tax Implications: Withdrawals from the policy basis, which are the premiums you have already paid, are generally not considered taxable income. However, if you withdraw more than your basis, the excess amount may be subject to income taxes. Additionally, withdrawals made during the first 15 years of the policy that reduce the policy's death benefit may also be taxable. It's important to consult with a financial professional to understand the tax implications for your specific situation.
• Impact on Death Benefit: Withdrawing funds from your cash value life insurance policy will likely result in a reduction of the death benefit. This means that your beneficiaries will receive a lower payout when you pass away. The extent of the reduction will depend on the amount withdrawn and the terms of your policy.
• Timing Constraints: Some policies may have timing constraints on withdrawals. For example, withdrawals might not be an option within the first two years of the policy. It's important to review the terms of your specific policy to understand any timing constraints that may apply.
• Potential Fees: Depending on the insurance company and the specific policy, there may be fees associated with making partial withdrawals. These fees can vary and are typically outlined in the policy contract.
• No Loan Obligations: Unlike taking a loan against your policy, a partial withdrawal does not incur loan interest charges or require loan repayment. However, the reduction in the death benefit remains, and any outstanding loans at the time of your passing will be deducted from the death benefit.
• Impact on Policy: Withdrawing funds from your cash value may impact the overall health of your policy. In some cases, if you withdraw too much, your policy could lapse or terminate. It's important to carefully consider the amount you withdraw and monitor the performance of your policy to ensure it remains in force.
• Alternative Options: Before making a partial withdrawal, consider exploring alternative options such as taking a loan against the policy, using the cash value to pay premiums, or surrendering or selling the policy. Each option has its own pros and cons, and the best choice will depend on your specific circumstances and financial goals.

Borrow against the cash value

Borrowing against the cash value of your life insurance policy can be a quick and easy way to get cash in hand when you need it. However, it's important to understand the risks and implications before making a decision. Here are some key things to know about borrowing against the cash value of your life insurance:

Eligibility

To be eligible to borrow against your life insurance, you must have a permanent life insurance policy with a cash value component. This includes whole life insurance and universal life insurance policies, which are more expensive than term life insurance but have no predetermined expiration date. It's important to note that term life insurance policies, which are cheaper and more suitable for many people, do not have a cash value and therefore cannot be borrowed against.

Loan Amount

The amount you can borrow against your life insurance policy depends on the insurer, but it is typically up to 90% of the policy's cash value. Each insurance company will have different rules, and you may need to wait until your policy has accrued enough cash value before you can borrow against it. This can take several years, depending on the structure of your policy and the premium amount.

Interest Rates and Repayment

Life insurance policy loans typically have lower interest rates compared to personal loans or credit cards, ranging from 5% to 8%. There is no formal repayment timeline, and you can pay back the loan whenever you decide. However, it's important to make regular interest payments to avoid accruing compounding interest. Failure to repay the loan and interest can result in your policy lapsing, and you may owe taxes on the amount borrowed.

Impact on Death Benefit

If you don't repay the loan before you die, the outstanding loan balance, including any interest owed, will be deducted from the death benefit. This means your beneficiaries will receive a reduced payout. It's important to consider the impact on your beneficiaries and discuss your decision with them.

Pros and Cons

Borrowing against your life insurance policy has several advantages, including no loan requirements or qualifications, low-interest rates, flexible repayment terms, and no impact on your credit score. However, there are also disadvantages to consider, such as the risk of reduced death benefit, policy lapse, and significant interest accumulation if the loan is not repaid. Additionally, borrowing against your life insurance may require several years of premium payments before there is enough cash value to borrow against.

In conclusion, borrowing against the cash value of your life insurance policy can be a convenient and low-cost financing option. However, it's important to carefully weigh the pros and cons and understand the potential risks before making a decision.

Surrender the policy for cash

Surrendering your life insurance policy means cancelling the policy and receiving its surrender value, which is the cash value minus any surrender fees. If you go down this route, your coverage ends, and your beneficiaries will not receive a death benefit when you die.

You'll owe taxes on the amount you receive that's above the cost basis. In other words, if you receive more than you paid in total premiums, you owe income tax on your earnings.

Surrender fees tend to decrease over time, so it's best to wait until the fee is minimal or non-existent. The longer you've held the policy, the larger the cash value portion will likely be.

When you decide to surrender your policy, contact your insurer to find out what your surrender value is and what fees apply. The fees are usually higher for newer policies and don't apply after 10 to 15 years.

You might also be able to sell your policy through a life settlement or viatical settlement. This involves selling your life insurance policy to a third party for more than the cash surrender value but less than the death benefit. Once a sale is complete, the buyer becomes responsible for paying your insurance premiums and maintenance fees for the rest of your life, and they receive the policy's death benefit when you pass away.

Use it to pay for long-term care

Using Cash Value Life Insurance to Pay for Long-Term Care

Seniors who lack sufficient savings or long-term care insurance coverage can use their life insurance policy to help pay for long-term care. Here are some options for doing so:

• Sell a policy for a life settlement: Policyholders can sell their life insurance policy to a third party for its market value and use the proceeds to fund a long-term care benefit plan. This option is available for any type of life insurance policy, but most companies require a minimum death benefit of $50,000. The shorter the policyholder's life expectancy, the larger the percentage of the death benefit they will receive. For example, a 90-year-old with a $100,000 death benefit could sell their policy and receive up to $60,000, which would be deposited into an FDIC-insured, irrevocable bank account managed by a licensed benefit management company.
• Set up a living benefit program: A living benefit program allows policyholders to receive a lump sum payment of up to 50% of their life insurance policy's death benefit while still reserving some death benefits for their family. To qualify, one must typically have a life insurance policy with a death benefit of at least $100,000, and the entire loan must be repaid, otherwise it will be deducted from the death benefit. Loan proceeds are not taxable, and interest rates may vary by state.
• Surrender the life insurance policy for cash value: Policyholders can give up ownership of their policy and receive the full amount of its cash value from the insurance company. However, taxes may need to be paid on this amount, depending on whether the cumulative premium amount paid is more or less than the current cash value. If the policyholder plans to use Medicaid to pay for long-term care, the cash portion of their life insurance policy may count against them for Medicaid eligibility.
• Take a loan from cash accumulation: Policyholders can take out a loan from their life insurance policy's cash value without paying taxes on it. However, they cannot take out the full amount, or the policy will lapse. Instead, they can take most of the cash value as a loan that they then pay back to themselves with interest.
• Use cash value to fund a new long-term care policy: Policyholders can use a tax-free 1035 exchange to use their current policy's cash value towards a new life insurance policy with long-term care insurance benefits, such as a hybrid policy that includes living benefits for costs related to strokes, cancer, or illnesses that long-term care insurance may not cover.

It's important to note that using life insurance to pay for long-term care can be complicated, so it's recommended to consult a financial expert before making any changes to your policies.

Frequently asked questions