Cash value can be utilized in several different ways to meet your financial needs. You can access your cash by taking out a policy loan, surrender your coverage, or purchase additional insurance. We will take a more detailed look at each case below.
Life insurance policy loans are the most well-known usage of cash value. Essentially, the insurer provides you with a loan with your cash value being used as the collateral. There are no requirements for how the money is used; you could purchase a car, take a vacation, or pay for medical expenses. It's very simple to take a loan; there is a form to fill out and interest rates are generally low, but interest needs to paid on time or it will be added to the loan balance.
Some of the benefits of taking a policy loan include:
It is critical to understand, however, that any outstanding loans you have at the time of your death decrease the death benefit by that amount. If you die with $20,000 in outstanding loans, the death benefit is decreased by $20,000. Also, if the size of your loan exceeds your current cash value amount, you will lose coverage and will likely have to pay income taxes on the loan.
Policy loans can be a tremendous benefit to those that need access to cash quickly and cheaply. Just like with any other loan, it's important to be responsible.
Individuals that still want to keep their life insurance but reduce their coverage to make the premium payments less expensive may want to consider taking a partial withdrawal. In this instance, you withdraw a portion of the policy's cash value, which decreases the death benefit by the same amount. A good example of this would be if you purchased a universal life policy to make sure your children were adequately covered in case something were to happen to you. Now that they are grown up and have steady careers, this is less of a concern. You are no longer worried about their financial well-being, but still want to retain some coverage for your spouse.
How a partial withdrawal affects your policy varies based on the type:
Universal Life - The death benefit is reduced dollar-for-dollar by the amount you decide to withdraw. As long as you withdraw less than the total of all your premium payments, the withdrawal is not taxable. If you withdraw more than what you have paid into the policy, you will owe income taxes.
Whole Life - Generally, it is not recommended to do a partial withdrawal from a whole life policy because your death benefit may be reduced by a greater amount than what you withdraw. If your policy is too large, it may be smarter to consider a life insurance settlement or surrender the policy.
If you no longer need life insurance because your dependents are financially secure, or your premium payments have become too expensive, you may want to think about a life insurance settlement. In a life insurance settlement, a company will purchase your life insurance policy from you at a value greater than your cash value, but less than the death benefit. You will be required to pay income and capital gains on the settlement, but you can generally get more money this way than if you were to simply surrender the policy.
Also, the broker involved in helping you sell the policy will take a cut of the earnings, so be mindful of that.
Individuals that can't get a settlement and still want to get rid of their policy can surrender their life insurance policy to the insurer. It's easy to do; simply let your insurer know that you want to surrender your policy, and they will pay you the net cash value. You can find your policy's surrender value in your statements.
It's important to note that you may be subject to surrender charges. Also, if you policy is relatively young, your net cash value may be less than the total cash value due to fees. However, if you policy is older, say 10 to 15 years old, your net cash value will likely equal or be close to the total cash value of the policy.
If you have a guaranteed insurability rider on your policy, you can use your cash value to purchase additional coverage. If you have a sizable cash value and don't plan on using it for anything, you can increase your death benefit. This ensures that your beneficiaries will receive the cash value instead of losing it when you pass. If you have a policy that pays dividends, you can use those to purchase insurance as well. Essentially, this is similar to purchasing a single-premium policy, meaning you purchase additional coverage for a one-time cost. There are no medical underwriting requirements or examinations when purchasing additional coverage, so you can increase benefits regardless of you health.
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