09 Jun I need money. What happens if I take or borrow from life insurance?
Q. Money is tight. I live on a fixed income and with inflation and higher prices, I need more money. My only real possibility, I think — so I don’t take money out of the stock market now that it’s down — is to either take a loan or a withdrawal from the cash balance of my life insurance policy. What should I be concerned about before I make a move?
— Pinching pennies
A. It’s a great question.
People often misunderstand what it means to take a loan or withdrawal from a life insurance policy.
There are many types of life insurance, but we will assume you have a traditional whole life policy.
Let’s start with policy loans.
Ed Gaelick, a Chartered Life Underwriter and Chartered Financial Consultant with PSI Consultants in Glen Rock, said you wouldn’t actually be taking a loan from your policy. Instead you’d technically be borrowing money from the insurance company.
“They’d loan you their money and charge you interest for the amount loaned and/or outstanding,” he said. “The loan interest percentage is likely contractual so check your policy for that amount.”
If you pay the loan back, or reduce it, any “unused” loan interest paid in advance would be refunded or reduce the loan interest balance, he said.
“You can keep a policy loan outstanding forever but the death benefit would be reduced by any loan,” he said.
Gaelick said loan interest would need to be paid until the loan is repaid.
Also, if you cashed out or surrendered the policy, the amount you get would be net any outstanding policy loan, he 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,” he 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.”
Withdrawing cash from a life insurance policy is different.
“If the planets are aligned, you may be able to `surrender the cash value of the paid-up additions’ if your benefit amount has increased over the years because of dividends,” Gaelick said. “This will reduce the death benefit but get you the cash you need without setting up a loan. It’s a great tool provided you are ok with permanently reducing the death benefit amount.”
Before you make any moves, speak to a professional who can examine your policy and go over your specific options.
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This story was originally published on June 9, 2022.
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.