Permanent life insurance policies – like universal, variable and whole life – offer more than a death benefit. Some include cash value, which is a reserve of money that you can use while you’re alive.
If you have had a policy for years, the cash value could be considerable. “The build-up could be more than what you invested, and that opens up all kinds of options,” says Jonathan Howard, a certified financial planner at SeaCure Advisors in Lexington, Ky.
The cash value of permanent life insurance is your money, to be tapped as needed, but your options for doing so will depend on the type of policy and the carrier. Before you do anything, ask the insurer how much you can safely withdraw per year based on the cash value balance and the terms of the policy. If you withdraw too early, the cash value of the policy could run out, forcing you to start paying more premiums or expiring coverage.
If you no longer need coverage, it can be tempting to stop the policy and cash it all at once, but consider the tax ramifications, says Luke Chapman, an associate at Precision Wealth Partners in New Castle, Del. . Any growth in the cash value above what you paid in premiums is taxed as ordinary income upon withdrawal. For example, if you paid $ 20,000, have a cash value of $ 100,000, and you withdraw the difference, the $ 80,000 of growth is taxable.
There are better ways to enhance that market value without increasing your tax bill.
A more tax-efficient option is to withdraw only what you need each year. Howard recommends keeping some money for an emergency fund, perhaps 12 months of spending, with the rest going to supplement your retirement income. Withdrawals first reduce tax-exempt premium payments; taxes are only due after you have started withdrawing winnings.
To borrow money
You can also leverage the cash value through a policy loan. You will not owe tax to withdraw your winnings this way. In addition, you will have the option to refund the money, while you cannot reverse withdrawals. If the money is not repaid, the death benefit will cover the loan balance upon your death.
The insurer will charge interest for the loan. “The interest rate is determined by the policy contract and is specific to the carrier,” Howard says. “It’s usually 4% to 8% per year.” Policy loan rates generally do not change with market conditions, he said, so don’t expect a deal today just because overall interest rates are low. Your remaining cash value can be used to pay interest.
Exchange it for an annuity
The IRS allows you to swap your permanent life insurance for an annuity through a 1035 swap, which is a tax-free transfer from one contract to another. This decision can generate more retirement income. “Let’s say the maximum payout stream for a cash value insurance policy is $ 10,000 per year. The conversion to an annuity could generate $ 12,500, ”says Chapman. An annuity could also guarantee that the payments will last your life, but you will void your life insurance policy, a decision that cannot be reversed.
Switch to a new policy to pay for long-term care
If you want long-term care coverage, consider converting your life insurance to another policy with a long-term care rider (if yours doesn’t already have it). You keep your life insurance, but part of the death benefit can be used to pay for long-term care costs.
Use it as collateral
Cash value is an asset that increases your chances of qualifying for a loan or mortgage from a lender. It can even be used as collateral for the loan, but Chapman cautions to structure the transaction carefully, as there may be tax consequences. Always ask an insurance expert before using the cash value in this way.
Tap it to pay the policy
The cash value can also be used to cover your life insurance premiums.
You don’t have to do anything with your monetary value. Left alone, monetary value will continue to accumulate, leaving a larger legacy for your heirs.because withdrawals and loans reduce the final death benefit.