You may have the option of taking a withdrawal or a policy loan against the permanent life insurance that you own. That is because permanent life insurance policies can create surrender value. Surrender value, commonly called cash value or accumulated cash value, can be withdrawn from the policy, borrowed from the policy, or used as collateral in order to borrow money directly from the life insurance company that issued the policy.
Each of these three scenarios can alter the growth, face value and death benefit of your permanent life insurance policy.
In a Universal Life Insurance policy, taking a policy withdrawal always reduces your cash values. You should be mindful of how much your cash values will be reduced by when taking a withdrawal because the cash values could be reduced to a level that require policy premiums to be paid out of your pocket instead of from your accumulated cash values.
In a Whole Life Insurance policy, reducing your cash values by taking a policy withdrawal will reduce your face value as well as your potential to earn higher dividends in the future. Knowing this before you take a withdrawal, is important in determining if a withdrawal is right for you.
Withdrawals from a Universal Life Insurance policy will reduce your accumulated cash value and reduce the interest you will earn in the policy in the future. But a withdrawal from a Whole Life Insurance policy will actually surrender part of your life insurance coverage (i.e., your face value) and adversely affect any future dividends that you might earn in that policy.
It is important to appreciate, that a policy withdrawal can trigger a tax liability for you. If your withdrawal is greater than your cost basis (premiums you have paid for your policy), then any amount of money over your cost basis in the withdrawal will be considered income for you in the year you take the withdrawal. Depending on your tax bracket, a policy withdrawal could end up producing a considerable amount of unnecessary and avoidable taxable income.
It is possible that a policy loan could accomplish the same thing you are attempting to do with a withdrawal, without adversely affecting your policy growth or producing a taxable event. This is something of which many policy owners are not aware, and they end up taking needless withdrawals when a policy loan would have been much more productive for them.
Universal Life Insurance policy loans are different than Whole Life Insurance policy loans. With Universal Policy Loans you may have the option of:
1) Borrowing your own accumulated cash values, or
2) Using your accumulated cash values as collateral for a loan from the insurance company
If you chose option one, you will be required to pay your loan back to the accumulated cash value account of your policy at a specified rate of interest determined by your insurance policy contract. If you opt for number two, you will be required to pay the insurance company back at a specified rate of interest that is determined by your insurance contract.
|Tools of the Trade - How to Use the Cash Value in Your Life Insurance A quick reference guide on how policy loans work, how to make loan repayments and how to track your loans.
In the first case, you will be paying yourself interest on your own money. In the second case, you will be paying the insurance company interest on the money they lent to you. In either case, you may or may not, be allowed to continue earning the rate of return on the amount borrowed, based on the contract the insurance company provided you at the time you initially started your policy.
Whole Life Insurance policy loans are unique in that you don’t ever borrow your own money from your cash values. With Whole Life Insurance policy loans, you always use your paid-up insurance as collateral for a loan which the insurance company lends to you. This keeps your cash values growing at the same guaranteed pace as if you hadn’t taken a policy loan.
In addition to this guaranteed growth, you can continue earning the annual dividend paid to policy holders in Participating Whole Life Insurance contracts. Some insurers will pay the same dividend regardless of whether there is an outstanding loan against your policy or not (this is called non direct recognition). While other insurers pay dividends on your cash value minus any outstanding loan balance you may have against your policy (this is called direct recognition). You can see more about direct vs non direct recognition here. Either way it is still possible for you to earn dividends while having an outstanding policy loan.
To initiate a policy loan is simple because it is a signature loan. You merely sign a loan request form provided by your insurance company, fax, mail or email it to the insurance company, and the insurance company either transfers the money into your bank account or mails you a check by US mail.
As simple as it is to take a policy loan, you must always account to see if taking the loan is in your best interest.
Taking a policy loan is a viable solution when you can either make more money or keep more money than you would without taking a policy loan. This may sound rather simplistic at first, but you must always do the math to assure that a policy loan taken will create more benefit for you than if you didn’t take the policy loan.
Your answer is easy. Keeping 7%, the difference between the 12% and the 5%, is a no brainer.
But what if the interest rate on your debt is only 3%, and your policy loan interest rate is 5%. Should you take a policy loan to transfer your debt to the insurance company instead of paying that interest to your creditor? Here is what you need to consider to determine the answer to that question:
Assume your policy has $10,000 of cash value and it is growing 2.75% annually. This means, you will have another $1,452.73 on top of that $10,000 in cash values in 5 years.
Without any policy to borrow from you would have lost the policy growth of $1,452.73, along with the $917.73 of interest you would have paid your creditor. This interest, plus your unrecognized policy cash value growth, would have been an unseen cost to you of $2,369.46.
With the policy, you keep about 55.35% ($1,548.74) of what you would have lost ($2,369.74) without the policy. That is why you must always do the math.
The cost of life insurance depends on various factors such as age, gender, lifestyle, and the specifics of the policy you choose. Insurers assess these elements to categorize you into a risk class, which influences your premium rates.
Given the individual nature of life insurance needs, a universal solution doesn’t exist. Consulting with a licensed insurance professional or a financial advisor can assist in identifying the most suitable insurer and policy for your circumstances.
Life insurance premiums are influenced by individual factors, including your age and health status. To get an accurate estimate of your potential life insurance costs, it’s advisable to consult with a licensed insurance representative.
The ability to take a loan against a life insurance policy varies based on the policy type and the rate at which it gains cash value. Generally, accumulating enough cash value to warrant a loan takes several years, and in many cases, it might be a decade or more before borrowing becomes a viable option.
The loan amount you can secure from your life insurance policy is tied to its accumulated cash value. Insurers generally permit loans up to 90% of this value, though certain policies may enable borrowing up to the full 100%. For precise figures, reviewing your policy details and consulting with your life insurance representative is advisable.
Life Insurance policy loans are a huge benefit to those who understand their limitations, availability and flexibility. They are a good way to help you manage your money better allowing you to keep more of what you make while building a more sustainable financial future that will be tax exempt for you and your loved ones as well. But as with any loan, you should always be aware of the implications and complications that can occur when you take a policy loan. Policy loans are not the panacea that many insurance agents paint them up to be abusing concepts such as The Infinite Banking Concept, Bank On Yourself, etc. But they are a viable options if you see the power of managing your own money instead of paying others a fee to manage it for you.
Dr. Tomas P. McFie
Most Americans depend on Social Security for retirement income. Even when people think they’re saving money, taxes, fees, investment losses and market volatility take most of their money away. Tom McFie is the founder of McFie Insurance which helps people keep more of the money they make, so they can have financial peace of mind. His latest book, A Biblical Guide to Personal Finance, can be purchased here.