Life insurance can provide much-needed cash for loved ones you leave behind when you die. That financial safety net for those who depend on you for support is the primary reason to buy a policy.
But life insurance also can provide cash for you while you’re living—that is, if you have a cash value life insurance policy. This is one of the perks of a permanent policy and a key reason it costs more than a term life insurance policy (along with lasting your entire life).
You can access the cash in a variety of ways. That’s right: It’s yours for the taking. Before you do this, though, understand your options and the pros and cons of each.
What Is Cash Value?
When you buy a cash value life insurance policy, the premium you pay doesn’t just go toward the death benefit—the amount that’s paid to your beneficiaries when you die. It also goes toward a cash value account and internal policy costs.
The cash value in a life insurance policy grows at either a fixed or variable rate, depending on the type of policy you have. A whole life insurance policy will have a fixed interest rate and usually pays dividends that will help the cash value grow. Universal life insurance often has variable rates, so cash value growth will depend on investment performance.
The cash value grows tax-deferred. You can even take cash out of a policy tax-free if you use the right strategy to access the cash.
Withdrawing the Cash You Need
Because the cash in a permanent life insurance policy is yours, you can withdraw it when you want. Simply call your insurance company to let it know how much you want to withdraw, and it will wire the cash to you or deposit it into your bank account, says Josh Hargrove, a Certified Financial Planner with Insight Wealth Partners in Plano, Texas.
Withdrawals are taken first from your “basis”—the amount you’ve paid into cash value through premiums. That money comes out tax-free because it’s considered a return of your basis. For example, if you have $50,000 in cash value and $30,000 of that is your basis, you could withdraw $30,000 tax-free. If you tap the earnings portion, though, you’ll have to pay taxes on the gains at your regular income tax rate, Hargrove says.
Withdrawing cash for a life insurance policy also will reduce the death benefit. That means your beneficiaries will get less when you die—which is something to consider before withdrawing cash from a policy.
Cash Withdrawal Pros and Cons
Borrowing the Cash You Need
Rather than withdraw cash from your policy, you can borrow it.
A life insurance policy loan can be a fast and easy way to get cash for a purchase such as a car, for retirement income or to help cover costs temporarily if you lose a job.
“Loans are the most common way policy owners access cash in a policy as they are completely tax-free,” says Chris Abrams, founder of Abrams Insurance Solutions in San Diego (as long you’re not borrowing from a modified endowment contract).
Plus, you don’t have to pay back the amount you borrow. But if you don’t pay it back, the amount will be deducted from the death benefit that is paid to beneficiaries.
Like any loan, though, there’s a charge to borrow. So the amount owed will grow over time due to interest charges.
The benefit of a participating loan is that you can continue to earn interest on the outstanding loan amount. For example, if the interest rate on the loan is, say, 5% and the return on your cash value is 7%, you’d still earn 2% on the amount you’ve borrowed, Abrams says. On the flip side, if the rate of return dropped to 0% in a down market, you’d have to pay the full 5% interest rate on the loan.
When borrowing from your cash value, you have to be careful not to borrow too much. If the amount of the loan plus interest owed reaches the total cash value of the policy, the policy can lapse.
Policy Loan Pros and Cons
Pros: No loan application or credit check. You can repay the loan on your own schedule, and the money goes back into your policy instead of to a lender. You may earn a positive arbitrage on the money you borrow.
Cons: The interest rate may be higher than other options. The loan will be subtracted from the death benefit if you don’t pay it back.
Surrendering the Policy for Cash
You can surrender your policy entirely to get the full cash value, minus any surrender charge. And you’ll have to pay taxes on any gains earned on the cash value portion of the policy. Plus, you’ll be giving up your life insurance coverage because surrendering a policy terminates it.
“Surrendering a policy is always the absolute last resort,” Abrams says. If you’re considering ditching your policy because you’re having trouble paying the premiums, you do have other options if you can’t pay your life insurance bill.
For example, you could reduce the policy’s face value to lower your premium, or use the cash value to convert the policy to paid-up status to keep some amount of coverage in place. You also can tap the cash value in your policy to pay your life insurance premiums temporarily if you’ve fallen on hard times. If you do this, be cautious not to deplete so much cash value that your policy lapses.
Policy Surrender Pros and Cons
Pros: If the policy has a surrender or cash value above the surrender charge, that is money in your pocket.
Cons: Possible surrender charges might wipe out any cash value. You might have to pay taxes. Your heirs will not receive a death benefit.
Sell Your Policy for Cash
You can get more than the cash value of your policy by selling it to a third party through a process called a life settlement. The third party will pay you a lump sum that’s less than the death benefit on the policy—but more than the cash value. The buyer will then pay the policy premiums. When you die, the investor collects the death benefit.
You could consider a life settlement if you have an immediate need for cash that trumps the need for life insurance.
You must be a certain age—typically 65—or have a certain level of health impairments in order to qualify for a life settlement. You’ll have better chances of selling your policy the older you are, says Lucas Siegel, CEO of Harbor Life Settlements.
You can be younger than age 65 to sell a life insurance policy through a life settlement, but you generally must be very ill. “Life settlements are calculated by understanding your life expectancy, and most third-party buyers prefer to purchase policies with a life expectancy of 10 years or less,” he says.
Being highly qualified by age and health condition also will help you get a bigger payment. Work with reputable life settlement companies, and get offers from more than one company.
Be aware that there can be fees associated with life settlements, and you’ll pay income taxes on the amount you receive from the sale of the policy.
Life Settlement Pros and Cons
Pros: You’ll get more cash than you would by surrendering your policy.
Cons: There are restrictions to qualify for a life settlement. The cash offer will be much less than the death benefit of the policy.
Look at Other Options
Before you choose any of these options for tapping the cash in your life insurance, speak with your insurance agent or financial advisor. Discuss how your policy will be impacted by each option. Also, consider whether there are better alternatives for coming up with the cash you need rather than using your cash value. If you bought the policy to provide a financial safety net for your loved ones after your death, you don’t want to jeopardize that by raiding your policy for cash.
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