If you are experiencing difficult financial times, you may start looking for options for borrowing money or withdrawing money from your investments in order to get caught up and turned around.
Before you pull money from a retirement account that will result in an early withdrawal penalty, or before you take on high interest debt that will only further hurt your financial situation, you might want to consider borrowing from a life insurance policy if you have one.
Not all life insurance policies offer cash value from which to borrow – but if you have a whole life policy, you may be able to take a loan from it.
The type of insurance matters
Life insurance is offered as term life policies or whole life policies. A term life insurance policy will provide money in the event that you pass away during the term of the policy (people usually get term life insurance for 20 or 30 year terms). If you do not pass away during the term of your policy, the money you paid is gone and there is no death benefit. Some people may qualify for a return of premium term life insurance policy, in which case you get back all of the money you paid toward the premiums if you do not die before the term is reached, but these policies are difficult to qualify for and are more expensive than your standard term life policy.
A whole life insurance policy will cost more than a term life policy during the first few years so that by the time you reach your high risk, older years – the premium you pay stays consistent rather than increasing with the increased risk. Some of the money you pay in those first few years of buying the policy is then available as a “cash value.”
Life insurance companies can charge a surrender fee to recover their expenses and sales commissions if you give up the policy before you die; and the difference between the cash value of your policy and the surrender value is the amount you are generally allowed to borrow – the “loan value.”
Borrowing from whole life insurance
One benefit of having a whole life insurance policy is that you can borrow money from the policy once it has earned a “cash value.” For example, a $100,000 police with a $50,000 cash value means that you can borrow up to $50,000.
If you do borrow from a whole life insurance policy, you should know that the amount of money you borrow reduces what the beneficiaries receive when you pass away – so you will want to set up a repayment plan on the money you borrow to pay it back as soon as you can to ensure your beneficiary gets the full amount of the death benefit.
For most whole life policies, you are not required to repay the money if you choose not to. If you don’t make payments on the money you borrow, you will at least have to pay interest on the amount of your loan each year.
Money taken from your whole life insurance policy is tax-free; since it is money you’ve already paid toward the policy premiums. If you are unable to repay the loan before you die, however, tax will be charged on the outstanding loan amount.
When it makes sense
If you are in need of money that you don’t have in a savings account or other easily accessible place and if your options for borrowing money are limited to high interest option, borrowing from your life insurance policy is the better choice. If you have good credit and could get a low interest loan, you should probably consider that before taking money from your insurance policy.