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Understanding Cash Value in Life Insurance
When you buy a permanent life insurance policy, a portion of the premiums you pay are set aside by the life insurance company in what is known as the cash value component of your policy. Over time, this cash value grows and can eventually be accessed for various purposes. You’ll need to pay premiums for several years before there’s enough cash value to be useful.
Term life insurance policies do not have a cash value component, but this type of policy is cheaper than a permanent policy as a result.
Whole life insurance policy cash value grows steadily but may not provide the same rate of returns as other types of permanent policies, such as universal life policies or indexed universal life insurance. These are tied to market indexes and can produce greater returns; however, if the indexes don’t perform well, you could lose money through lower overall returns. The latter policies also allow you to adjust your life insurance premiums up or down within a certain range to give you added flexibility. The best life insurance for you will depend on your budget and financial goals, among other factors.
How To Get Cash From Your Life Insurance Policy
You can access cash from your life insurance policy in several ways.
Withdrawal
A policy owner can take a partial withdrawal from a permanent life policy, and it is usually not subject to income taxes as long as it’s not more than the amount you’ve paid into the policy. However, your death benefit will likely be reduced, and that reduction may be greater than the amount you withdraw, depending on the specific terms of your policy.
Surrender
Surrendering your policy means to cash out of a life insurance policy completely. In return, you’ll get the surrender value of the cash value of your policy. However, you won’t have life insurance coverage any longer, and you’ll have to pay surrender fees, which can be significant.
Loan
You can usually borrow money through your policy but will pay interest charges on the life insurance loan amount for this privilege. Rates are typically lower than with a personal loan or home equity loan; and because there’s no loan application or credit check, your credit rating will not be impacted.
You can choose not to repay a policy loan, but the outstanding loan balance will be deducted from your death benefit.
Should You Withdraw From Your Life Insurance?
You have several options to withdraw funds from the cash value of your life insurance and access cash if you need it for unexpected reasons such as a medical issue or other large expense. For example, you might be better off taking out a second mortgage on your home, using a zero-interest credit card or tapping into savings.
If you’ve had your policy for more than a decade, you may have significant funds you can tap, but understand that doing so may shrink the size of your policy’s death benefit payout. You may also be on the hook for taxes in addition to charges, depending on what option you choose.
You should discuss options with your financial advisor or an experienced insurance agent who can help you decide what’s optimal for your particular situation. Much of this will depend on your age, overall finances, how much money you need, long-term financial goals and retirement planning and other considerations.
Process for Getting Cash from Life Insurance
Your policy terms and conditions will give you specific directions on accessing the accumulated cash value from your policy. If you have questions after reviewing this document, contact your life insurance agent or the policy provider directly to get more information on the steps to follow and what documentation you’ll need to submit.
Payments minus the fees are usually made between 14 and 60 days after a request is received.
Other Considerations and Alternatives
If you need a cash infusion, you have other options instead of taking cash value from your life insurance policy.
Credit Cards
Think about using an existing credit card with a cash advance option. How much you can access depends on the card’s terms, your existing credit limit and what percentage of your limit you can use for an advance. This may solve a short-term money challenge, but it often comes with a cash advance fee and high interest rates, while potentially lowering your overall credit score.
A better credit card alternative is to add a 0% introductory APR credit card which can extend “free money” to you for as long as 18 months, depending on the issuer. During the promotional period, interest charges won’t accumulate as long as you make on-time payments for at least the minimum amount due. This often makes better sense than other options if you’re sure you can pay off the credit card balance before the promotional period ends and the interest rate increases.
Personal Loans
A personal loan is often a good choice if you want a sizable amount of cash for a specific purpose. Personal loans usually charge lower interest rates than credit cards. If you have good credit, you can shop around for competitive rates through banks, credit unions, online lenders or other similar lenders.
Home Equity Loans
A home equity loan lets you borrow against a portion of the increased value of your home. How much you can borrow starts by subtracting the balance on your mortgage from the current market value of your home to arrive at your current home equity amount. People often use home equity loans for big purchases, home renovations, college expenses or to consolidate higher-interest debts.
Interest rates on a home equity loan are often lower than those for credit cards and personal loans. But you will have to pay closing costs of anywhere from 2% to 5%, and you’re putting your home at risk of foreclosure if you fall behind on loan payments.
The Bottom Line
Using your life insurance policy’s cash value can give you much-needed flexibility for unforeseen circ*mstances. However, you do have other options that may be a better way to protect your long-term financial planning efforts. Consider all your alternatives and discuss which is the best for you with a life insurance agent or financial advisor.
Frequently Asked Questions
The money in your cash value life insurance policy often grows tax-deferred, meaning you won’t need to pay taxes as long as the money remains in the account. There could be tax implications if you withdraw money through a loan, withdrawal or surrender. Always consult with a tax professional or financial advisor before changing your life insurance policy.
The length of time varies by insurer, but in most cases, cash value does not start to accrue until you have paid premiums for two to five years.
When a policyholder dies, the insurer pays the death benefit to beneficiaries but keeps the cash value balance. Policyholders who try to get around this provision may take a loan on their policy, but the death benefit amount is reduced when they do so.
Sometimes you may accrue more cash value than the face value death benefit of the policy, usually after many years of paying a premium. In this case, you can ask your insurer to increase your death benefit, use your cash value to pay your premiums or withdraw some of the cash value.
Methodology: Our System for Ranking the Best Life Insurance Companies
Our team researches and ranks life insurance companies using an in-depth scoring system that considers the factors most important to consumers like you. Our analysis includes a comprehensive review of each provider we feature based on available coverage, customizability, availability, customer service and company reputation. Here are the factors we take into consideration when rating life insurance providers:
- Brand trust (40%): Life insurance payouts can exceed $100,000 or more, which makes choosing a reputable and trustworthy installer important. To assess brand trust, we use J.D. Power and Associates customer satisfaction surveys, AM Best credit rating scores and the National Association of Insurance Commissioners (NAIC) complaint index. The higher a company scores in each area, the more points it receives.
- Coverage (33%): The more policy options a life insurance company offers, the more opportunities you have to obtain the right coverage for your specific needs. For this reason, we give companies the most points for offering multiple types of life insurance, including various term, permanent and no-exam options.
- Availability and ease of use (19%): Since life insurance coverage options can be complex, we consider the ways a customer can reach a company — and how easy communication is. For this category, we research how many communication channels a company offers for general customer support, claims processing and the application process. Companies earn the most points for offering various ways to interact with an agent, both in-person and online.
- Riders (8%): Companies offering various life insurance riders or endorsem*nts allow policyholders to better customize their coverage. In this category, we determine how many riders a company offers and award the most points to providers with more than 10 options.
We use our rating system to compare and contrast each company against key factors to help us determine the best life insurance companies in the industry. To learn more, read ourfull life insurance methodologyfor reviewing and scoring providers.AM Best Disclaimer
Drew GurleyContributing Writer
Drew Gurley is a licensed life insurance expert with nearly 15 years of experience. During his career as both a licensed life insurance agent and industry executive, he has helped thousands of clients with their life insurance needs through his work at Redbird Advisors and Senior Market Advisors. When Drew isn’t working, he spends time with his family, supporting breast cancer and epilepsy awareness.
Sabrina LopezSenior Editor
Sabrina Lopez is an editor with over six years of experience writing and editing digital content with a particular focus on home services, home products and personal finance. When she is not working on articles to help consumers make informed decisions, Sabrina enjoys creative writing and spending time with her family and their two parrots.
