How to Borrow Cash from Life Insurance

What is Cash Value?

Whole and universal life insurance premiums are accounted for in two separate ledgers that form the coverage. When the premium is paid the money goes into what is referred to as the policy value. The policy value is where both the expenses related to the coverage and the interested credited to the account are calculated. Once the policy value has been debited and credited, what is left is referred to as the cash surrender value. This is the money available to the policy owner as a withdraw or a full cash surrender.

How Can I access Cash Value in Life Insurance?

To access the cash in the policy you first have to have accrued some! In the initial years of any policy the majority of the policy value is being debited more than credited by your cost of insurance and surrender charges to discourage early cancellation. On average it takes about 5 years before any cash has begun to build in the cash value ledger. Once cash value has accrued there are three ways to tap into it:

Policy Loan

A policy loan is the removal of cash value from your policy with the promise to repay that money. Remember the company uses your premium to offset the risk of having to pay out thousands, or millions, in the case of an untimely death. When that cash given in consideration of such coverage is removed there must be some sort of corresponding effect on the policy. The total balance of cash loaned out of a life insurance policy will be deducted from the death benefit if a death claim were made. Before any claim is made, while the loan is outstanding, an annual interest rate will be charged on the balance. If this annual rate is not paid it will be taken out of the existing cash value as an another loan to be added to the total loan balance. Because the nature of this transaction can put the policy at risk of lapse, we always advise clients against policy loans until the cash value balance is substantial enough to easily absorb these costs. The biggest benefit of taking out the cash as a loan is that although your cash value ledger will be debited, the policy value will remain unchanged. The policy value balance is what is used to calculate the interest that is credited to the account. So this means that you can continue to compound interest on cash in the policy that technically is not even there!

Cash Withdraw

A withdraw is the permanent removal of cash without the promise to repay. Removing cash in this manner will be interest free, but it will result in a permanent reduction in both death benefit and cash value. With no promise to repay, the money is also removed from the policy value ledger and so with it the chance to continue to accrue interest on it.

Full Surrender

The permanent and final removal of all cash from a policy is known as a full cash surrender. In this transaction the death benefit ceases, and all cash is disbursed minus any previously taken loans. Although this is the cleanest way of removing cash from life insurance, it also opens one up to tax implications. Any time cash is withdrawn or surrendered out of a life insurance policy and the proceeds exceed the premiums put in, the policy will be assessed capital gains tax. One way around this taxation is the IRC 1035 exchange. This provides policy owners with 60 days after a full cash surrender to transfer that money into a new life insurance policy with being taxed on any gains.

Should I Borrow Cash from Life Insurance?

Because the nature of life insurance is first risk mitigation and not an investment, we always caution those who start a policy with expectations of using it as a slush fund. The cost of coverage, fees, and surrender charges make life insurance one of the least efficient methods of generating return on cash. Now that is not to say that the major tax advantages (see estate planning or IRC Sect. 162) and indexed crediting strategies available on todays policies can not create a significant financial reward. The approach however of using cash in a life insurance plan should always be measured against the primary purpose of the policy, to pay out a large death benefit in the case of death. A knowledgeable advisor should always be consulted before making any decisions to remove cash value from a life insurance policy.