Life insurance doesn’t have to only be used when you pass away. A permanent life insurance policy gains cash value, which is money you can withdraw while you’re still living.
The money you borrow from the policy reduces the death benefit of the policy if you don’t repay the loan while you’re living. If the loan isn’t paid back before the insured person passes away, the loan amount plus any interest owed is subtracted from the amount the beneficiaries would receive from the death benefit.
Permanent life insurance policies, such as whole life and universal life, build up cash value that collects interest. Only a partial amount of the total cash value can be borrowed, unless you want to surrender the entire policy and take the entire cash value.
Where does the cash value come from? The monthly premiums paid into the policy exceed what’s needed for the death benefit, and that money is invested by the insurance company. A cash value is created after a few years.
It can be borrowed against, and the policy is collateral for the loan. Common uses for these loans are paying off a mortgage, retirement income, paying debts and paying for college.
To start, verify with your insurer that you have enough cash value to take out a loan. They will give you forms to complete, and after you get the loan, you can keep up loan payments if you want. The loan amount doesn’t count as taxable income and interest rates are lower than a traditional loan.
If the loan isn’t repaid while you’re living, the death benefit could be reduced. If the interest on the loan and the unpaid loan balance exceeds the policy’s remaining cash value, you could lose your policy.
A term life insurance policy, which is cheaper and used by most people, can’t be borrowed against. Term policies don’t have a cash value and the policies expire after a certain term, usually from one to 30 years.
Cash value from an insurance policy can also be used to pay the insurance premiums if you’re short on cash, according to the Insurance Information Institute. This can happen if you face unexpected expenses, such as a hospital stay, and can’t afford to make payments on an insurance policy. If you use all of the cash value funds, the policy could lapse, and your life insurance coverage could end.
If your beneficiaries don’t need the money from an insurance policy, then borrowing against it can be a good way to pay immediate bills and fund retirement. But if you think they will need the money, then either find another type of loan or pay back the insurance policy loan over time.
