When you’re scrambling for cash in a crisis, your life insurance policy might never cross your mind. You 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. Taking money from your policy could increase your tax burden, and you risk leaving your family short on funds if you die. But if you’re in a financial bind, tapping the cash value of a whole life insurance policy could be a reasonable option.
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, such as whole life, that has had time to build cash value.
Term life insurance doesn’t qualify. It’s typically the most affordable type of life insurance, but the main trade-offs are that term life 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 part of the premium goes into an investment 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, variable universal life and indexed universal life, may also have cash value.
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.
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 should eventually reach the death benefit of the policy, but that may not happen until you’re 100 years old.
Four ways to tap life insurance cash value
If your policy has cash value, you can tap it 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 family won’t get a death benefit when you die. Depending on how long you’ve had the policy, you might pay a penalty for cashing out early. And if your payout is more than the premiums you paid, you could owe income tax on that gain. Surrendering your policy may not be a good idea unless you’re certain you no longer need the life insurance to provide for your family after you die.
Make a withdrawal
You can usually withdraw part of the cash value in a whole life policy without canceling the coverage. Instead, your heirs will receive a reduced death benefit 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 a life insurance loan, you’re generally expected to repay it with interest at some point. If you die before paying it all back, the amount you owe is deducted from the benefit paid to your heirs.
Cover your premium
If you need money to pay bills, and one of those bills is the life insurance premium itself, your cash value may 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.