A term life insurance policy is good enough for a lot of people. It’s relatively affordable, and it does what you expect a life insurance policy to do: Pay a death benefit if you pass away so your family has a financial safety net.
There’s another type of life insurance called permanent life insurance. Permanent life insurance doesn’t have an end date, and stays in force for as long as you pay for the policy. The most common type of permanent life insurance is whole life insurance. Whole life insurance has one big leg up over term: It’s a type of cash value life insurance.
The cash value component of a life insurance policy is, in simple terms, an investment vehicle. It’s money that can grow while you have your policy. It can get a little confusing, which is why some people might opt for a simpler term policy. However, the cash value component lets you do things you can’t with a term life insurance policy to help reach your financial goals.
The whole life cash value component can be valuable in getting a loan, preparing for retirement and making your policy pay for itself.
Take out a loan
One thing you can do with a cash value life insurance policy is use it as a loan. This isn’t the same as withdrawing money from it. You’re borrowing against your policy. As with other loans, it accrues interest until you pay it back.
A whole life insurance loan is different because you’re borrowing against your own policy and you technically don’t have to pay it back. If you don’t, and you die, the amount you owe will be deducted from your death benefit.
As always, you should consider whether you need a loan, or if you should just save for something. Whole life insurance policies often offer lower interest rates than you’d get elsewhere, which makes them enticing, but remember that you’re mixing a loan and a life insurance policy, so failure to pay it back can have bigger consequences than you’re used to.
Use it on your policy
In a bit of "Inception"-level logic, you can use your whole life insurance policy to fund your whole life insurance policy. Basically you’re using value you build up and putting it back into the policy. You can do this in one of two ways.
First, once you’ve built up enough of a cash value, you can stop paying premiums and use the cash to fund the policy. That can be handy, as a whole life insurance policy tends to cost more than a comparable term life insurance policy. If you can get a few months (or more) of relief from paying for the policy, that can help you keep it in force.
You can also use dividends paid out by the policy to increase the death benefit and cash value. You are, essentially, buying more, smaller amounts of insurance to add to your policy. If you see your financial situation changing and need more coverage, this option is available to you with the policy you already own.
Supplement your retirement savings
Even if you have retirement savings, do you know it’s enough? Many financial experts tout the “4% rule:” You use 4% of your savings in each year of your retirement. But maybe you don’t have that much saved up, or you’re more likely to use 7% or 8%. Or consider that a few bad years for the market can put your savings at risk.
With a whole life policy, you can access the built-up cash value component instead of dipping into your savings. This allows you to be strategic about your retirement spending. For example, after a down year in the market, you can use the cash value — which is mostly insulated from market downturns — instead of your individual retirement account, allowing your savings to replenish. When you’re withdrawing money from your policy, it’s generally free of income tax, and you can take up to the total in premiums paid.
If you’re considering this, make sure you have other retirement options in place first, like an IRA or a 401(k). Those should still be the primary way you fund your retirement, but whole life insurance can be a worthy supplement.
Surrender the policy & take the cash
If you really want the cash value — and, more importantly, don’t want the life insurance anymore — you can surrender your insurance policy and receive money equal to the whole life cash surrender value. You can go here to learn more about canceling a whole life insurance policy. However, there are a few key things you should know when you do:
- If you surrender the policy during the surrender period — usually the first two to three years of owning it — you may not get any of the cash value, or you may be subject to steep fees. Even during the first 10 or so years, you may still have to pay surrender fees.
- You won’t have a life insurance policy anymore. Obviously. That means that you lose the death benefit. Have a plan in place when you surrender a policy, whether it’s buying a term life policy or being self-insured.
- The surrender value is subject to income tax. Here’s how we explain it in the article above:
At a basic level, the cash value you get out of your whole life policy is tax free, but there’s an exception. If the amount you receive is larger than the "basis" of the policy, you’ll be taxed on the amount over the basis. You can determine the basis by taking all the premiums you’ve paid into the policy and subtracting any dividends you’ve been paid, any cash you’ve already withdrawn and any agent commissions or administrative fees paid by your premiums.
The above are just a few options for using the cash value of a whole life insurance policy; there are even more out there, like receiving a guaranteed income. There’s lots to consider, and that’s a double-edged sword: It can be confusing, but it also offers different ways to make your finances work.
Whenever you’re thinking of doing something with the cash value of your whole life insurance policy, talk to a licensed insurance agent or a financial adviser. They can let you know the implications of doing so and any alternatives available to you so you don’t make a mistake that costs you your savings and your life insurance.