14 Jun Should I take a 401(k) loan to pay for my life insurance?

Q. I’m having trouble making payments on my whole life policy, and the cash value isn’t enough to cover the premiums. I really don’t want to let it lapse. I do have money in a 401(k) and I could take a loan and use that to pay the premiums. What do you think?
— In trouble

A. A whole life insurance policy is a long-term investment. If you let the policy lapse, you won’t have much to show for it and you’ll lose the insurance protection.

Set aside the 401(k) loan option for a moment, and let’s talk about what you can do to keep the policy in force.

If it’s a pure whole life policy, you locked in premiums contractually when you were younger, are building cash value and have a permanent benefit – provided premiums are paid, said Ed Gaelick, a Chartered Life Underwriter and Chartered Financial Consultant with PSI Consultants in Glen Rock.

If you are having trouble making premium payments, Gaelick said, you may have these options.

First, if the policy is “participating,” meaning you share in profits of the company in the form of dividends, and dividends are being used to increase cash value and increase the death benefit, you may be able to change your dividend option to reduce or offset current and future premiums, Gaelick said.

“That would either reduce your premiums or if dividends are enough, cover premiums entirely,” he said. “Dividends can be changed back to increase values at any time should financial circumstances improve.”

Another option could be if your policy has an Automatic Premium Loan, or APL, provision. The carrier will loan against your cash value, if enough, to cover any premiums not paid, Gaelick said.

You said your cash value is not enough to cover your premium, but maybe it could cover it for a short period of time if your situation is temporary, he said.

“Make sure your premium `mode’ is changed to monthly, if not already,” Gaelick said. “That keeps the benefits active yet does set up a policy loan.”

He said loans have an interest cost, but the repayment options are very flexible. So in essence, you’d be borrowing from the insurance company, which uses your policy as collateral, he said.

If your death benefit has increased over time because dividends have purchased “paid up additions,” you can surrender the cash value of the paid up additions and use that money to pay premiums, Gaelick said.

“The death benefit and your cash value will reduce but not beyond your policy guarantees,” he said. “Surrendering paid-up additions is an income tax free transaction since it will almost certainly be less than your cumulative premium – cost basis – assuming your policy is not a Modified Endowment Contract.”

If none of these options work for you, is it wise to borrow from your 401(k) plan?

Gaelick said you should only do that as an absolute last resort for several reasons.

First, when you borrow from a 401(k) plan, you are really selling funds, he said. Depending on the timing, you could be selling at a gain or you could lock in a loss.

“The plan administrator would set up an amortization schedule for you, for which there would be a cost, and you would need to repay the loan over some period of time with some reasonable interest rate,” Gaelick said. “The argument is you are paying yourself back but again, you may have locked in a loss.”

Also, he said, by reducing your 401(k) holdings, you’ll have fewer shares that may take advantage of any upswing in the market, or you could lose an opportunity to recapture your losses for the shares you sold.

And if you lose your job, you’ll have to pay back the loan quickly otherwise it will be considered a non-qualified withdrawal, leading to penalties and taxes.

“Lastly, you’d be taking out money from the plan, repaying the loan with after-tax dollars so when you ultimately take money out of your plan at retirement, the repaid loan dollars are taxed again,” he said. “I’d look into all other options first.”

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This story was originally published on June 14, 2019.

NJMoneyHelp.com presents certain general financial planning principles and advice, but should never be viewed as a substitute for obtaining advice from a personal professional advisor who understands your unique individual circumstances.