26 Sep Should I use my whole life policy cash value to pay for college tuition?

Q. My mother bought me a whole life policy when I was a teenager and it now has a cash value worth $100,000. I have tuition to pay for my son’s college soon. What would happen if I used it?
— Bills to pay

A. Congratulations on your son’s college attendance.

When it comes time to pay tuition bills, you’re smart to look at all of your possible resources.

For your question, we will assume your policy is a pure whole life policy, not universal life or variable life.

For a whole life policy, there are several ways to use the cash value, said Ed Gaelick, a Chartered Life Underwriter and Chartered Financial Consultant with PSI Consultants in Glen Rock.

First, you can surrender the policy for its cash value, Gaelick said.

“You’d have no more insurance but you’d have $100,000 in cash,” he said. “However, there might be a tax consequence. Any amount of gains would be income taxable at your marginal tax rate.”

Gains would be calculated by subtracting your “cost basis,” or the cumulative amount paid in premiums, from the surrender value, or $100,000, he said. So if the cumulative premiums paid over the years were $60,000, there would be tax on a $40,000 “gain.”

This also assumes no miscellaneous transactions such as loans or partial surrenders during the life of the policy, he said, because those could affect the cost basis.

Next, you could surrender the cash value of any paid-up additions.

“This option would only be valid if the whole life policy’s original death benefit increased over time by using dividends,’ Gaelick said. “You’d in essence surrender only the cash value of the additional insurance, so you receive a lot less than $100,000 and the death benefit would revert back to the original amount purchased.”

This would be an excellent option if the cash needed were minimal and you wanted to maintain the policy with no loans, he said.

The last option is to borrow against the life policy cash values.

“And to clarify, you are not borrowing from your whole life policy,” he said. “You are using the cash values in your whole life policy to borrow from the insurance company. They use your policy values as collateral.”

You would pay a loan interest charge to your insurance company, Gaelick said.

“The repayment for a Life loan is very flexible, which could benefit some, yet could also be a detriment to others that may not be as diligent with repayment,” he said. “There is no tax consequence to borrowing money against your life policy. So if maintaining the death benefit is important to you, consider borrowing.”

Just note that premiums will need to continue to be paid with a loaned policy unless your policy is paid up, he said.

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This story was originally published on Sept. 27, 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.