If you are strapped for cash, you might consider taking out a loan against your life insurance policy. Is it wise? Let's walk through why it might not be.

When you’re financially strapped for cash, you start looking for money in any place you can find it. Believe it or not, your life insurance policy may give you access to cash…but it will come at a cost. 

Not all life insurance policies offer the ability to take money out. Even if they do, it may not be a good idea. It’s good to know your options in case taking cash from a life insurance policy is a necessity. 

Not all life insurance policies allow you to take cash out

Looking For Cash? Why You Should Think Carefully About Taking A Loan From Your Life Insurance Policy - Not all life insurance policies allow you to take cash out

Life insurance comes in two major varieties. The first is term life insurance. This type of insurance is a no-frills version that offers life insurance for a set period at the lowest cost possible. For this reason, the policy doesn’t accumulate any cash value. That means you can’t take cash out of a term life insurance policy.

The other significant type of life insurance policy, permanent life insurance, has several sub-types. Permanent life insurance policies generally last for your whole life and cost much more than a term life insurance policy. 

One of the benefits commonly cited about permanent life insurance policies is the cash value they build over time. Part of your premium goes toward building this cash value in different ways depending on your policy’s sub-type. Some sit in a cash account. You can invest others to potentially grow over time.

Despite the allure of the benefits a permanent life insurance policy offers, these policies aren’t usually the best use of your money. Getting a term life insurance policy and investing the difference in premiums between a permanent and term life insurance policy generally puts you in a much better position. That said, some people prefer the comfort of permanent life insurance policies. Ultimately, the decision is up to you.

Ways to access cash from a life insurance policy

Looking For Cash? Why You Should Think Carefully About Taking A Loan From Your Life Insurance Policy - Ways to access cash from a life insurance policy

You may already have a permanent life insurance policy and need cash. Depending on your type of permanent life insurance policy, how long you’ve had it, and your policy’s details, you may be able to access cash from your permanent life insurance policy in one of several ways. 

Here are a few options you may have. Consult your policy for details.

Take out a loan from your life insurance policy

Your permanent life insurance policy may allow you to take a loan against your cash balance. Generally, your cash balance must grow to a certain amount before you can take a loan out. Once you reach that threshold, a loan against your policy could be easier than getting a traditional loan.

Life insurance loans don’t require credit checks or lengthy approval processes. The life insurance company already has the cash value of your policy as collateral. Instead, they set up the loan and designate an interest rate.

You don’t even have to make payments to repay the loan technically, but it’s a good idea. When you borrow against your cash balance, you risk your policy lapsing. If your loan amount exceeds your cash value, your policy typically terminates.

When you don’t make payments on your loan, the interest gets added to the loan’s balance. Over time, this can add up faster than your cash value builds. Additionally, any loan amount that remains outstanding at the time of your death reduces the death benefit paid to your beneficiaries. 

Withdraw money from the cash value

Your policy may allow you to permanently take the money out of your permanent life insurance policy’s cash value. This has profound impacts, though, and should be very carefully thought through before you do it.

Withdrawing money from the cash value you’ve built up may seem like a smart move. You did pay money and purchase a permanent life insurance policy partially to build cash value. Sadly, it has other impacts that may defeat the purpose of this part of your policy.

In particular, permanently withdrawing the money from your cash value could lower your policy’s death benefit. In fact, some life insurance policies reduce your death benefit by more than the amount of cash value you receive. This could leave your loved ones without the money you intended to leave them when you took out the life insurance policy.

You should always check your particular life insurance policy for details to see how this would work in your situation. The impacts may be minor enough where it’s the best option for you. In other cases, you may find yourself considering another way to access your policy’s cash value.

Surrender the policy completely

Sometimes, people realize they made a mistake buying permanent life insurance. If you’re still young enough and healthy enough to get a term life insurance policy, you may decide you want to get rid of the whole life insurance policy. 

This process is called surrendering the life insurance policy. When you surrender a life insurance policy, the policy’s cash value is paid out to you. Unfortunately, it’s not that straightforward. 

Life insurance companies build in a fee, called a surrender charge, to punish people for canceling their life insurance policies early in the policy’s life. This happens because the companies need time to recover the costs of establishing your policy. 

The surrender fee reduces the cash you receive from the cash value of your policy. The surrender fee may decline over time and should eventually disappear altogether. Even so, canceling with a surrender fee may make sense if you can get a cheaper term life insurance policy that meets your needs and you need the cash.

Use the cash value to pay your policy’s premiums

People usually want to access their policy’s cash value to pay an unexpected expense or regular bills when their income dries up. People don’t consider that their life insurance policy is one of the bills they use their money for. If they can avoid paying their life insurance bill, they could instead use the money they would have used to pay their life insurance premiums for unexpected expenses or other bills.

Some permanent life insurance policies offer this option. In some cases, you can use part of the cash value to cover your premiums for a few months. 

Another option is getting rid of your premiums altogether. This is often referred to as making the policy paid up. Essentially, it takes the cash value of your policy and uses it to alter your life insurance policy. 

Based on the dollar amount of the premiums you’ve paid and your cash value, your insurer will offer you the option to alter your death benefit in exchange for never making premium payments again. This could drastically reduce your death benefit. 

Some people may have more death benefits than they need, though. If reducing the death benefit fits within your needs, you could keep the reduced death benefit and never make premium payments on the policy again.

Consider the impact of taking cash out of your life insurance policy

Looking For Cash? Why You Should Think Carefully About Taking A Loan From Your Life Insurance Policy - Consider the impact of taking cash out of your life insurance policy

Taking money out of a life insurance policy leaves you in a bad spot as far as life insurance is concerned. People that take out a loan and don’t repay their life insurance policy could leave themselves with a smaller death benefit. This puts their family at risk, assuming they still need the full death benefit to cover necessary expenses after death.

Similarly, surrendering the policy, straight out withdrawing cash value, or paying the policy’s premiums with cash value can reduce or eliminate your death benefit. If you’re able to secure term life insurance at an affordable rate, this may not be a big problem. 

People may think that they can get new life insurance for a similar price. Unfortunately, prices generally go up as you get older. If you’ve developed any significant health issues, this can increase costs too. In fact, some people may now be uninsurable as far as life insurance is concerned.

Before you take money out of a life insurance policy in any way, consider the impacts. Investigate whether you can get new life insurance to cover your needs.

After you’ve considered the impacts, consider your other options for getting access to cash. You may be able to take out a personal loan, borrow money from family, or get a credit card with a 0% introductory APR on purchases. While none of these situations are ideal, you have to decide if they’re a better fit than potentially jeopardizing your life insurance policy.

Summary

If you have a permanent life insurance policy, you may have ways to access cash from the policy if you need to. The methods to take money out aren’t ideal and could leave you with less life insurance coverage or no life insurance coverage at all. 

However, the need for cash may be larger than the need for life insurance. Only you can decide which is best for you given your current situation.

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About the author

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Lance Cothern is the founder of a href="https://www.moneymanifesto.com/">Money Manifesto, a personal finance blog that helps people to master their money so they can live their ideal life. In addition to blogging, he enjoys spending time at the beach with his family. You can connect with Lance on Twitter, Facebook, and LinkedIn.