Permanent life insurance policies, which include universal, variable, and whole-life options, offer more than just a death benefit. Some policies include cash value, which can be a pool money that you can use while you are still alive.
The cash value of a policy that has been in existence for many years could be substantial. Jonathan Howard, a certified financial advisor with SeaCure Advisors, Lexington, Ky., says that the accumulation can be greater than what you put in. This opens up many options.
Permanent life insurance’s cash value is your money. You can tap it as often as you need, but the type of policy and carrier will determine your options. Ask the insurer before you do anything. This will help you determine how much cash you can withdraw each year, based on your policy terms and the cash balance. You could lose your policy’s cash value if you withdraw too soon.
It might seem tempting to cancel your coverage and cash out the policy immediately, but it is important to consider the tax implications, according Luke Chapman (a partner at Precision Wealth Partners in New Castle Del). When you withdraw cash, any increase in cash value beyond what you paid for premiums is subject to tax. If you withdraw $80,000 and have $20,000 in cash value, then $80,000 is taxable.
There are other ways to use that cash value that won’t increase your tax bill.
It’s a great way to live!
It is more tax-efficient to only withdraw what you actually use each year. Howard suggests that you keep some money in an emergency fund for 12 months to cover expenses. The rest can be used to supplement your retirement income. Drawdowns draw down the tax-free premium payment first. taxes will be owed once you have started withdrawing the gains.
A policy loan can be used to tap into the cash value. This way, you won’t have to pay taxes. You’ll be able to repay the money. However, you cannot reverse withdrawals. The death benefit will pay the balance of the loan if the money isn’t repaid.
The loan will be charged interest by the insurer. Howard explains that the interest rate will be determined by the policy contract, which is carrier-specific. Howard says that the interest rate is typically between 4% and 8% per year. He also states that policy loan rates do not change with market conditions. So don’t expect to get a deal just because general interest rates are low. The interest can be paid with the remaining cash value.
You can exchange it for an Annuity
You can swap your permanent insurance for an annuity by using a 1035 exchange. This is a tax-free, tax-deferred transfer of one contract to another. This can increase retirement income. Let’s assume that the maximum payout stream from a cash-value insurance policy is $10,000 per year. Chapman states that converting to an annuity could generate $12,500. An annuity can also ensure that the payments last your whole life. However, you will have to cancel your life insurance policy. This cannot be reversed.
Change to a new policy to pay for long-term care
If you want coverage for long term care, convert your existing life insurance policy into a policy with a long care rider. Your life insurance can still be purchased, but a portion of the death benefit may be used to cover long-term care expenses.
Your chances of getting a loan or mortgage are increased if you have a cash value. Although it can serve as collateral for a loan, Chapman cautions that you should structure the deal carefully to avoid tax consequences. Before using cash value in this manner, consult an insurance professional.
Tap it to pay for the policy
You can also use the cash value to pay your premiums for life insurance.
It’s okay to leave it alone
Your cash value is yours to keep. The cash value can be left alone and will continue to grow, creating a greater inheritance for your heirs. Withdrawals and loans decrease the final death benefit.