Life insurance is a fundamental aspect of financial planning, primarily designed to provide financial security to your loved ones in the event of your untimely death. However, life insurance policies, particularly certain types of permanent life insurance, offer more than just a death benefit. They can also serve as a financial resource during your lifetime. Many people are surprised to learn that they can access money from their life insurance policy under certain conditions. This article will explore the different ways you can get money from your life insurance, the implications of doing so, and the considerations you should keep in mind.
Types of Life Insurance
Before diving into how you can access money from your life insurance, it is essential to understand the different types of life insurance and how they work. Life insurance policies generally fall into two main categories:
Term Life Insurance: This type of life insurance provides coverage for a specific period, such as 10, 20, or 30 years. If you pass away during the term, your beneficiaries receive the death benefit. However, term life insurance does not accumulate cash value, meaning you cannot access money from it during your lifetime.
Permanent Life Insurance: This category includes whole life, universal life, and variable life insurance. These policies provide coverage for your entire life, as long as premiums are paid. Unlike term life insurance, permanent life insurance policies accumulate cash value over time, which can be accessed while you are still alive.
For the purposes of this article, the focus will be on permanent life insurance, as it is the type of policy that allows you to access money.
see also: What is a Non-Linked Insurance Plan?
Accessing the Cash Value of Your Policy
One of the most significant features of permanent life insurance policies is their cash value component. A portion of your premium payments goes into a cash value account, which grows over time based on the policy type. This cash value can be accessed in several ways, providing you with a financial resource during your lifetime.
1. Borrowing Against the Cash Value
One of the most common ways to access money from your life insurance policy is by taking out a loan against the cash value. Life insurance loans offer several benefits compared to traditional loans:
No Credit Check: When you borrow against your life insurance policy, the insurance company does not conduct a credit check, making it an accessible option for those with less-than-perfect credit.
Flexible Repayment: Life insurance loans typically offer flexible repayment terms. You are not required to repay the loan on a specific schedule, and you can choose to repay it at your own pace. However, it is essential to understand that if the loan is not repaid, the amount, plus interest, will be deducted from the death benefit when you pass away.
Lower Interest Rates: Life insurance loans often have lower interest rates compared to traditional personal loans or credit cards. The interest charged on the loan is usually added to the outstanding balance, which can grow over time if not repaid.
While borrowing against your life insurance policy can be a convenient way to access funds, it is important to note that the loan is secured by your policy. This means that if the loan is not repaid, the death benefit your beneficiaries receive will be reduced by the outstanding loan balance plus any accrued interest.
2. Withdrawing Cash from the Policy
Another way to access money from your life insurance policy is by withdrawing cash from the cash value account. Unlike a loan, a withdrawal does not need to be repaid. However, withdrawals can have several implications:
Tax Consequences: In many cases, the cash value can be withdrawn up to the amount of the premiums you have paid without incurring taxes. However, if you withdraw more than you have paid in premiums, the excess amount may be subject to income tax.
Reduced Death Benefit: When you make a withdrawal from your life insurance policy, the death benefit may be reduced by the amount of the withdrawal. This means that your beneficiaries may receive less money upon your death.
Policy Lapse Risk: Excessive withdrawals can also put your policy at risk of lapsing. If the cash value drops too low, the policy may no longer be able to cover the cost of insurance, leading to a lapse in coverage.
Withdrawals can be a useful way to access money from your life insurance policy in emergencies or when you need funds for a specific purpose. However, it is crucial to weigh the potential impact on your policy’s death benefit and long-term viability.
3. Surrendering the Policy for Its Cash Value
If you no longer need your life insurance policy or can no longer afford the premiums, you may choose to surrender the policy in exchange for its cash value. Surrendering your policy means that you give up the death benefit, and the policy is terminated. In return, the insurance company pays you the cash value that has accumulated in the policy.
There are a few important considerations when surrendering your policy:
Surrender Charges: Many life insurance policies include surrender charges, particularly in the early years of the policy. These charges are deducted from the cash value, reducing the amount you receive.
Tax Implications: Similar to withdrawals, the cash you receive from surrendering your policy may be subject to income tax if it exceeds the amount of premiums you have paid.
Loss of Coverage: Surrendering your policy means that you lose the life insurance coverage it provided. This decision should be made carefully, considering whether you or your loved ones still need the protection that life insurance offers.
Surrendering your life insurance policy can provide a lump sum of cash, which can be useful if you need a significant amount of money. However, it should be considered a last resort, as it results in the permanent loss of your life insurance coverage.
4. Using Policy Dividends
If you have a participating whole life insurance policy, you may be eligible to receive dividends from the insurance company. These dividends are typically based on the company’s financial performance and can be paid out annually. There are several ways you can use these dividends:
Take the Dividends in Cash: You can choose to receive the dividends as cash payments, which you can spend or save as you see fit.
Apply Dividends to Premiums: Dividends can be used to reduce or fully pay your life insurance premiums, lowering your out-of-pocket costs.
Purchase Paid-Up Additions: You can use dividends to purchase additional life insurance coverage, increasing your policy’s death benefit and cash value.
Leave Dividends to Accumulate: You can leave dividends in the policy to accumulate with interest, effectively growing the cash value over time.
Using policy dividends can be an effective way to access money from your life insurance without reducing the death benefit or taking on debt. However, dividends are not guaranteed and may vary from year to year.
5. Accelerated Death Benefit Rider
An accelerated death benefit rider is an optional feature that can be added to many life insurance policies. This rider allows you to access a portion of the death benefit while you are still alive if you are diagnosed with a terminal illness, a critical illness, or a chronic condition. The funds can be used for any purpose, including medical expenses, living costs, or other financial needs.
The amount you receive through an accelerated death benefit rider is typically subtracted from the total death benefit, reducing the amount your beneficiaries will receive. However, it can provide crucial financial support during a difficult time.
Things to Consider Before Accessing Your Life Insurance Funds
While accessing money from your life insurance policy can provide valuable financial support, it is important to consider the following factors:
Impact on Death Benefit: Any money you take from your life insurance policy—whether through loans, withdrawals, or accelerated benefits—will reduce the death benefit that your beneficiaries receive. Carefully weigh this impact before accessing funds.
Tax Implications: Depending on how you access the funds, you may incur tax liabilities. Consult with a financial advisor or tax professional to understand the potential tax consequences.
Policy Sustainability: Excessive loans or withdrawals can deplete the cash value, potentially causing your policy to lapse. Ensure that your policy remains sustainable over the long term if you plan to access its cash value.
Alternative Options: Before tapping into your life insurance, consider other financial resources or strategies that may be available. Life insurance is a valuable asset, and it is important to preserve its benefits for your loved ones.
Conclusion
In conclusion, while life insurance is primarily designed to provide financial protection to your loved ones after your death, it can also serve as a valuable financial resource during your lifetime. Permanent life insurance policies offer several ways to access money, including loans, withdrawals, policy surrenders, dividends, and accelerated death benefit riders. Each method has its benefits and potential drawbacks, and it is crucial to understand the implications before accessing funds.
If you are considering tapping into your life insurance policy’s cash value, it is advisable to consult with a financial advisor to ensure that the decision aligns with your long-term financial goals and does not jeopardize your policy’s primary purpose of providing for your beneficiaries. By carefully managing your life insurance policy, you can maximize its benefits both during your life and for your loved ones after your passing.
