02 Jun Using your life insurance policy’s cash value for college

 Q. I have a whole life policy with a cash value of $26,000. Next year, my son will be going to college. I know we haven’t saved enough. Should I take the cash value to pay for college, or not? What do I need to watch out for?

A. When you’re facing college bills, you’re smart to consider all of your options.

For those who have whole life insurance policies, you have the option of taking a loan against your policy’s cash value, or canceling the policy and withdrawing all of the cash value.

Let’s first talk borrowing.

“Whole life allows you to borrow `against’ the accumulated cash value. You are not borrowing `from’ the policy,” said Ed Gaelick, a Chartered Life Underwriter and Chartered Financial Consultant with PSI Consultants in Glen Rock.. “The carrier gives you their money and uses your policy as collateral.”

Insurance companies will charge “loan interest,” which is typically a contractual amount, such as 7.4 percent, depending on the carrier, Gaelick said.

One bonus is that the amount borrowed is not subject to taxation.

“Should you die with an outstanding loan, the amount of the loan will reduce the death benefit,” Gaelick said. “Thus, policyholders have the use of their cash value tax-free for purposes other than insurance.”

So should you? That depends.

Gaelick said while you can borrow against your cash value, you may be able to get a better rate at a bank or by securing a student loan.

“If you can’t get a better rate or would have difficulty securing a loan, the whole life policy would be a good option,” he said. “By borrowing, you keep the benefit. The carrier will only require you to pay the loan interest. Principle repayment is not required but it’s best to repay over time to establish reciprocity on the life policy.”

Your second option would be to cancel the policy and withdraw the cash.

But if you need the insurance, that may not be a good idea.

When you surrender a life insurance policy for cash, you must include in income any proceeds that are more than the cost of the life insurance policy, said Bernie Kiely, a certified financial planner and certified public accountant with Kiely Capital Management in Morristown.

“In most cases, your cost — or investment in the contract — is the total of premiums that you paid for the life insurance policy, less any refunded premiums, rebates, dividends, or unrepaid loans that were not included in your income,” he said.

You’d receive a Form 1099-R showing the total proceeds and the taxable part.

Kiely said canceling the policy isn’t necessarily the smartest move, though.

“If you cancel the policy and withdraw the cash values you are no longer insured,” he said. “I am in favor of the policy loan. You can always change your mind later. Please think twice about cancelling the policy.”

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This story was first posted in June 2015.