Life Insurance Cash Fund: A Smart Financial Move?

Life insurance is often thought of as a way to provide for loved ones after you pass away. However, some life insurance policies can also be used as a financial asset during your lifetime. This is where the concept of a life insurance cash fund comes in.

Life insurance policies that offer a cash fund component are known as permanent life insurance or cash value life insurance policies. These policies allow the policyholder to build up a cash value over time, which can then be accessed in a variety of ways. The cash value typically grows tax-deferred, providing a tax-efficient way to save for the future.

There are several types of permanent life insurance policies that offer a cash value feature, including whole life insurance, universal life insurance, and variable universal life insurance. These policies differ in terms of flexibility, investment options, and potential for growth.

Accessing the cash value in a life insurance policy can be done through withdrawals, loans, or surrendering the policy. However, it's important to note that doing so will reduce the death benefit and may have tax implications.

While permanent life insurance policies with a cash value feature offer several benefits, they also tend to have higher premiums compared to term life insurance policies, which do not accumulate cash value. As such, it's important to carefully consider your financial goals and needs before deciding which type of life insurance policy is right for you.

Borrowing against life insurance

When borrowing against life insurance, there is no approval process or credit check, and the money can be used for anything from bills to a financial emergency. Interest rates for life insurance loans are typically much lower than for bank loans or credit cards, ranging from 5% to 8% according to MarketWatch. Additionally, life insurance loans are generally not recognised by the IRS as income, so you won't have to pay taxes on them. However, if the loan is not paid back, it will reduce the death benefit and may cause the policy to lapse, resulting in owing taxes on the borrowed amount.

The maximum amount that can be borrowed against a life insurance policy is typically up to 90% of its cash value. It is important to note that borrowing against life insurance can reduce the death benefit and may have other financial implications, so it is recommended to thoroughly consider the pros and cons before taking out a loan.

Withdrawing cash from the policy

Withdrawing cash from your life insurance policy can be done in several ways, but it's important to remember that this will usually reduce the death benefit for your beneficiaries and may have tax implications. Here are some common methods for withdrawing cash from a life insurance policy:

Withdrawing Funds

You can make a direct withdrawal from the cash value of your policy, just like you would from a bank account. This option typically doesn't require you to pay taxes on the amount withdrawn, as long as it doesn't exceed the total amount you've paid into the policy. However, if you withdraw more than you've paid in, the withdrawal may be taxed as income. Withdrawing funds can reduce the death benefit for your beneficiaries and may be subject to partial surrender charges.

Taking a Loan

You can borrow against the cash value of your policy and use the money for various purposes, such as emergencies, paying college tuition, or supplementing retirement income. The loan amount will accrue interest until it's paid back in full, and if you pass away before repaying the loan, the loan amount and interest will be deducted from the death benefit.

Surrendering the Policy

You can cancel your policy and take the "surrender value", which is the cash value minus any surrender charges. This option terminates the policy, so you will no longer have life insurance coverage. Surrendering the policy may result in a potentially large sum of money, but it will leave your beneficiaries with no payout after your death. Additionally, the funds received may be taxed if they exceed the amount you've paid into the policy.

Using Cash Value to Pay Premiums

Instead of withdrawing money for expenses, you may be able to use the cash value of your policy to pay your insurance premiums, freeing up funds in your budget for other expenses. This option allows you to maintain your life insurance coverage while managing your finances. However, it's important to note that using the cash value for premiums may reduce the amount available for other expenses, and there is a risk of policy lapse if all funds are used.

Life Settlement

In a life settlement, you sell your life insurance policy to an individual or a life settlement company in exchange for cash. This option typically results in a higher payout than surrendering your policy, but it comes with several downsides. You give up control of the death benefit, and the new policy owner will have access to your medical records and updates on your current health. The life settlement industry is also marginally regulated, making it difficult to determine if you're getting a fair price for your policy. Additionally, commissions and fees can reduce the net amount you receive.

Surrendering the policy

Surrendering your life insurance policy means cancelling it and receiving the cash value that has built up over time, minus any surrender fees. This option is only available for permanent life insurance policies, such as whole and universal life insurance, as term life insurance policies do not accrue cash value.

There are a few things to consider before surrendering your life insurance policy. Firstly, if your policy is not very old, you may incur surrender fees, which will reduce the amount of cash you receive. Secondly, the gain on your policy will be taxed as income. While death benefits are tax-exempt, the cash received from surrendering a policy is taxable. Therefore, it is important to consult a tax professional before making any decisions.

Additionally, surrendering your policy means forfeiting your life insurance coverage. This may be a good option if you no longer need the coverage, but it is important to consider the financial implications carefully.

• Withdrawing: You can make a direct withdrawal from the cash value of your policy. If the amount withdrawn includes investment gains, it may be taxable as income. However, this option allows you to maintain your life insurance coverage.
• Borrowing: You can take out a loan against the cash value of your policy. The loan amount will accrue interest, and if you pass away before repaying it, the loan amount and interest will be deducted from the death benefit.
• Using cash value to pay premiums: You can use the cash value of your policy to help pay your premiums, making it easier to keep your coverage.
• Selling to a third party: This is similar to surrendering your policy, as you will no longer have coverage. However, the amount received may vary, and you may be subject to commissions and fees that reduce the final amount.

Before making any decisions, it is recommended to consult a trusted financial professional to discuss all your options and find the best path forward for your specific situation.

Using cash value to pay premiums

Life insurance policies that accrue cash value are typically permanent, meaning the policyholder has coverage for their entire life, as long as the premiums are paid. The cash value of a life insurance policy is separate from the death benefit, so beneficiaries will not receive the cash value when the policyholder dies.

There are several types of permanent life insurance policies that accrue cash value, including:

• Whole life insurance
• Universal life insurance
• Variable life insurance
• Indexed universal life insurance

Each time a premium payment is made on a cash value life insurance policy, the money is split into three categories:

• The cost of insuring the policyholder
• The insurance company's fees and operating costs
• The policy's cash value

As the policyholder ages, the amount of money allotted to the cash value decreases, while the amount paid to insurance increases.

If enough cash value is built up in a life insurance policy, it can be used to pay the policy's premiums. However, this strategy may only work for a short period, as the cash value must remain large enough to cover the premium payments. Whole life insurance policies typically do not allow the policy's cash value to be used to pay premiums, except if the policy is converted to a paid-up policy.

Tax advantages

Life insurance is often thought of as a way to provide for loved ones after you're gone, but it can also be a financial asset during your life. Permanent life insurance policies, such as whole life and universal life insurance, offer a cash value feature that can provide several tax advantages. Here are some of the key tax advantages of permanent life insurance policies with a cash value:

Tax-Free Death Benefit:

The death benefit from a permanent life insurance policy is generally paid to the beneficiary free of federal income tax. This provides a tax-efficient way to ensure your family has the resources to maintain their standard of living, pay off mortgages or debts, or carry out education plans for your children.

Tax-Deferred Cash Value Growth:

Permanent life insurance policies allow your premium to fund not only a tax-free death benefit but also a cash value account that grows tax-deferred. This means that as long as the policy remains in force, you won't owe taxes on the growth of your policy's cash value, potentially enabling you to accumulate more savings over time. This feature can be particularly beneficial for those in a higher tax bracket during their working years who expect to be in a lower tax bracket during retirement when withdrawals are made.

Tax-Advantaged Withdrawals and Loans:

Permanent life insurance policies offer flexibility in accessing the cash value through tax-advantaged loans or withdrawals. You can borrow against the cash value of your policy, generally on a tax-free basis, to supplement retirement income, pay for unexpected expenses, or fund education. Withdrawals up to the total amount of your premium payments are typically tax-free, while withdrawals on gains may be taxed as ordinary income. These options provide greater flexibility to use your funds as you see fit. However, it's important to remember that loans and withdrawals from the cash value may affect the death benefit amount and could require additional premium payments.

Estate Tax Planning:

While estate taxes may apply to life insurance death benefits, the exemption threshold is typically high, resulting in few individuals owing estate tax. Additionally, strategies such as establishing an irrevocable life insurance trust (ILIT) can help mitigate potential estate tax liabilities. By using the trust to purchase a permanent survivorship life insurance policy, the death benefits are distributed to the trust, shielding them from estate and income taxes.

Tax-Free Accumulation of Cash Value:

The cash value within a permanent life insurance policy, such as whole life insurance, grows tax-free. This means that you are not required to pay income tax on the growth as long as the funds remain within the policy. This feature makes permanent life insurance an attractive option for individuals seeking to maximize tax benefits while also securing financial stability for themselves and their loved ones.

Frequently asked questions