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When you’re scrambling for cash in a crisis, your life insurance policy might never cross your mind. You probably bought it to provide for your family when you’re gone, but you’re still here and looking for ways to pay your bills. In some cases, a permanent life insurance policy, such as whole life, might provide the emergency cash you need.
However, borrowing or withdrawing money from your policy could increase your tax burden and incur loan interest charges, and you risk leaving your family with less money than you intended if you die before paying it back. Learn how to get cash from your policy and weigh the pros and cons before tapping the funds.
Does your life insurance have cash value?
Not all life insurance policies have funds tucked away inside. To get cash out of your life insurance, it needs to be a permanent policy that has had time to build cash value, which can take years.
Term life insurance doesn’t qualify. It’s typically the most affordable life insurance, but the main trade-offs are that term life purely offers insurance coverage, lasts for a limited time and has no cash value. You can’t take money out of this type of policy.
Permanent life insurance often costs much more than term life, but when you pay your premium, part of it is funneled into a cash value account that you may be able to tap. Whole life insurance, also sometimes called ordinary or straight life insurance, is the most common type of permanent policy. Other variations, such as universal life insurance, variable universal life insurance and indexed universal life insurance, may also earn cash value over time.
» MORE: Term vs. whole life insurance
If your policy is relatively new, it’s unlikely to have much cash value yet. Building cash value is like growing a savings account with small deposits over time. You’ll typically need to pay premiums for several years before there’s enough cash value to be useful. Plus, permanent life insurance policies have high surrender charges — or early withdrawal penalties — for the first five to 15 years the policy is active, so that cost might be prohibitive.
Also, be aware that the cash value of your policy can be much less than the total premiums you’ve paid or the amount of insurance you bought. If your whole life policy’s cash value grows undisturbed, it can eventually reach the death benefit amount, but that may not happen until you’re 100 years old — and that’s assuming you haven’t missed any premium payments or taken out other policy loans or withdrawals. With other types of permanent life, the premiums and performance of the policy will determine whether the cash value matches the death benefit amount.
» MORE: Best life insurance companies
Four ways to tap life insurance cash value
If your policy has cash value, you can access the money for whatever you need, but taking cash out of your life insurance policy is a serious decision. Details differ from one policy to the next, so be sure to read your contract or check with your agent before you take action. Here are four options to consider.
Surrender the policy
You can cancel your life insurance policy entirely and receive the “surrender value,” which is the cash value minus any fees. If you choose this option, you won’t be covered by the policy anymore, and your beneficiaries won’t get a death benefit when you die. Depending on how long you’ve had the coverage, your policy may have a penalty for cashing out early, known as a surrender charge. And if your payout is more than the premiums you paid, you will most likely owe income tax on that gain. Surrendering your policy may not be a good idea unless you’re certain your beneficiaries no longer need the life insurance payout.
» MORE: Who needs life insurance?
Make a withdrawal
You can usually withdraw part of the cash value in a permanent life policy without canceling the coverage. Instead, your life insurance beneficiaries will receive a reduced payout when you die. Typically you won’t owe income tax on withdrawals up to the amount of the premiums you’ve paid into the policy. This option may also be called a partial cash surrender since you are surrendering part of your coverage.
Borrow from the policy
Many policies allow you to borrow against the cash value. Borrowing against life insurance may be easier than getting a loan elsewhere because there’s no credit check and a flexible timetable for repayment. When you take out a life insurance loan, you’re generally expected to repay it, with interest. The insurance company will continue to pay dividends and interest on the borrowed cash value, but this amount is almost always lower than it would be for nonborrowed funds. If you die before paying it back, the amount you owe is deducted from the death benefit.
Cover your premium
If you need money to pay bills, and one of those bills is the life insurance premium itself, your cash value can come in handy. You may be able to skip making out-of-pocket premium payments on your whole life policy. Instead, you can use the cash value to cover your premiums for a while, keeping your policy safe while you weather a financial storm.
Any type of withdrawal or policy loan can have a long-term impact on the performance of your policy. Before committing to pulling cash value from your policy for whatever reason, request an “in-force illustration” from your life insurance company. This outlines how the move you’re planning to make will affect your policy’s financial performance.