When funds are borrowed from a cash value life insurance policy, the policy holder will pay no income taxes. This is because these funds are treated as being a debt, and not a taxable distribution.
A policy loan, however, should be paid back. This is because the balance on the loan will be charged interest. In addition, should the policy holder pass away while there is still an unpaid loan balance, this amount will be deducted from the total amount of death benefit proceeds that are received by the policy’s beneficiary.
In addition, life insurance policy loans that are taken from a cash value life insurance policy will also likely have associated administrative costs and other fees. With this in mind, a policy holder should carefully consider exactly how much the borrowed funds will cost prior to taking a policy loan.
Alternatively, the cash value in a life insurance policy can provide policy holders with a viable option for obtaining funds that are needed for an emergency situation or to pay off other high interest debt such as a credit card balance.
What is Cash Value Life Insurance
There are many different types of life insurance policies on the market today. The two primary classes of life insurance include term and permanent. Term life insurance is considered to be the most basic form of coverage, providing a certain amount of death benefit in exchange for a premium payment. Should a policy holder pass away during the “term,” or time frame, of the policy being in-force, a beneficiary (or beneficiaries) will receive the death benefit proceeds. Term life insurance does not offer any type of underlying cash value build up.
Permanent life insurance provides policy holders with an amount of death benefit, along with a cash value or savings component. With these plans, individuals can accumulate a significant amount of savings over time that may be borrowed or withdrawn should the individual have need for the funds. Therefore, in addition to providing a death benefit, cash value life insurance can offer a number of other advantages.
Most life insurance policies do require the applicant to undergo a physical exam, to determine how much of risk they may be to the insurance company, though there is the option of looking into a no medical exam life insurance policy, at a high premium rate.
Types of Life Insurance Policies that Contain Cash Value
There are several types of life insurance that offer an underlying cash value option. These include:
- Whole Life Insurance – On top of providing death benefit proceeds, whole life insurance policies also offer a savings component that allows the build-up of cash – typically at a minimum guaranteed rate of interest. This cash accumulates on a tax deferred basis, meaning that the gain on these funds will not be taxed until the time that the policy holder withdraws the money. Policy holders can usually withdraw or borrow this cash for paying off debts, funding a child’s future education fund, paying emergency expenses, or for nearly any other purpose that they see fit. The cash that is contained within a whole life insurance policy can also be borrowed. Because the funds are considered to be a loan in this situation, income taxation can be avoided. However, although it is not required, the balance of the loan should be repaid. Otherwise, any unpaid loan balance that remains at the policy holder’s death will be deducted from the amount of the death benefit proceeds. For details click here.
- Universal Life Insurance – With a universal life insurance policy, cash value will grow over time based on the underlying interest rate. Similar to with whole life insurance, a portion of each premium paid into a universal life policy will go towards funding the death benefit, and a portion will also go to funding the cash value component. Universal life insurance policies essentially offer their policy holders two death benefit options. First, the death benefit can remain level, while the growth of the cash value can help in offsetting the potential periodic increases in the monthly insurance charges. The other option allows the policy’s death benefit to equal the initial amount selected by the policy holder, plus the amount of the cash value. The needs of the individual policy holder should determine which option is ultimately selected. More details here.
- Variable Life Insurance – Variable life insurance policies offer a combination of death benefit protection along with an opportunity for investment. These plans provide the ability to invest in professionally managed investments – and, depending upon the performance of these underlying investments, the cash value in a variable life plan could grow substantially over time. Similar to both whole life and universal life, a variable life insurance policy holder may have access to his or her cash through either a withdrawal or loan option. Visit this page for more information.