Q. How does cash value work with life insurance? Can I take out the money without penalty at any age, and what are the advantages or disadvantages? I was thinking of using it to help pay for my daughter’s wedding.
A. You have many options with certain life insurance policies.
Whole life insurance, which builds cash value, has a borrowing provision that allows the owner of the policy to borrow against the total cash value of that policy.
The insurance company loans the owner the money and uses the policy as collateral, said Ed Gaelick, a Chartered Life Underwriter and Chartered Financial Consultant with PSI Consultants in Glen Rock.
“They don’t care if a loan ever gets paid back since if not, they would reduce the cash value at policy surrender or death benefit at time of death,” Gaelick said. “The only thing they would require is the annual loan interest to be paid.”
Deposits to repay the loan can be quite flexible, Gaelick said, and you can pay basically any amount up to the outstanding loan amount at any time.
The money borrowed can be used for any reason, including your daughter’s wedding, and there are no age restrictions, Gaelick said.
“If a policy holder borrows against the cash value from his or her life insurance policy, the amount borrowed is not subject to taxation,” Gaelick said. “This reasoning is in accord with tax policy on other types of loans, such as consumer loans or home mortgages. These loans are merely transfers of capital or savings from one person to another through a financial intermediary.”
He said there is no limit to the number of loans outstanding provided they total less than the cash value. The accounting of multiple loans would be the insurance company’s responsibility and it can get tricky with multiple loans.
If you keep adding loans, the loan interest keeps increasing, which suppresses the net growth of the policy, Gaelick said.
“Since the loan interest rate, a policy contractual amount, may be better than a loan from the market, a whole life policy may be a good asset to borrow against – not from,” he said. “Just keep in mind the loan does reduce values proportionally in the event of death or policy surrender.”
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