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Understanding Cash-Value Life Insurance: Borrowing Money From Your Policy (Part 3)

by John Bearss on March 26, 2011 · 2 comments

An excerpt from Follow the Money Weekly Radio with Jerry Robinson – 3/26/11

To hear the entire program, click here.

by John Bearss

Transcript

Over the last few episodes of financial strategies I have been talking about why cash value life insurance should be considered when developing a person’s overall retirement planning strategy.  So today, I want to continue by talking about different ways of taking the money out of your cash value life insurance policy and the rules to each.

Let’s review what cash value life insurance is.  When you pay premiums on a cash value life insurance policy, some of your money is applied toward the policy cash value, which is similar to a savings account within the policy. Over time, the cash values accumulate. Then at some point during your lifetime, you can access the cash value by taking a withdrawal, or a policy loan, or surrendering or canceling your policy.

Last week, the first word we talked about was withdrawals and how it would affect your cash value life insurance policy.  Today, I am going to focus on the words policy loans and how it would affect that same policy.

Policy loans are when you borrow money against your cash value. Policy loans are allowed under the terms of your insurance contract and are not affected by your current financial position. In other words, you won’t have to undergo a credit check or go through the bank loan approval process for a policy loan. When you take out a policy loan, the check you receive comes out of the general funds of the insurance company and not your cash value. Your policy cash value serves as collateral for the loan.

The interest rate on a policy loan is known in advance and may be lower than that on a bank loan. Some policies allow you to borrow at an interest rate only slightly higher than the rate being credited to the cash values.  And other policies have what they call zero net cost loans and this is when the interest rate on the loan equals the rate credited to the cash value.

So what are the advantages and disadvantages of taking a policy loan instead of a withdrawal?

The first disadvantage is that the interest does accrue on any unpaid loan balance.  In other words, if you choose not to repay the loan, the accruing interest may erode your cash values and result in the lapse of the policy.  This is why it is important to work with someone who can show you how much loan you can take so that it does not trigger a taxable event.  The second disadvantage of a policy loan is that if you die with an outstanding policy loan against your account, your death benefit is reduced by the amount of the outstanding loan balance.

If you have worked with an insurance agent who understands how loans work there are some excellent reasons why loans could be of major benefit to you.

The main benefit of policy loans is that the loan proceeds are generally not subject to income tax. This is true even if the loan is larger than the amount of premiums or the cost basis you have paid into the policy.

Let’s say that you own a life insurance policy (which is not a MEC) with a cash value of $20,000 and your cost basis or the amount of premium you paid into the policy is $17,000. Then you decide to take a policy loan to pay your daughter’s college tuition. Under the terms of your policy, you are allowed to take a loan for an amount up to 90 percent of the policy cash value, in this case $18,000.  If you take the $18,000 loan, you are not subject to tax on the amount of the loan, even though the loan is larger than your basis.

Building cash inside a life insurance policy has many advantages to you and is one of the most tax efficient ways of accumulating money and taking distributions.  However, I want to warn that it is important to work with someone that has an excellent understanding of how these concepts work.

Next week, I will conclude this series on cash value life insurance with the concept of combining withdrawals and policy loans and what happens if you decide to surrender your policy.

Again if you have any questions concerning today’s topic or if you would like to get a second opinion to your current retirement planning strategy you can contact me by e-mail at john@cfanetwork.org and when you write me, let me know how I can best contact you and I would be more than happy to discuss your financial situation personally with you.

I trust this financial insight has been helpful and I look forward to the next time when I can help you provide the foundation for a lifetime of financial independence.

About John Bearss: John R. Bearss is a Retirement Specialist with the Christian Financial Advisor Network. He has been helping clients and financial professionals understand financial strategies for 24 years. To speak with John Bearss directly, email him at john @ cfanetwork.org or call (800) 609-5530.

Disclaimer: John Bearss is a registered representative of and does offer securities through Sicor Securities, Inc.  Lifetime Decisions Management, nor it’s representatives provide legal or tax advice.  Please consult your CPA or qualified tax advisor before making any decisions. Lifetime Decisions Management, Inc. is not a subsidiary of nor controlled by SICOR Securities, Inc.

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John Bearss
John has been working with folks who are retired or near retirement for over 27 years. He has done several financial educational seminars and has been part of the “Follow the Money” Radio show. His two primary goals for his clients are to make sure they are good stewards of what God has entrusted to them, and secondly, to provide the foundation for a lifetime of financial independence.
  • chad demeuse

    John,

    I opened a cash value life insurance policy with NorthWestern Mutual last year, I am 34, in really good health and because I told my dr. that I smoked a couple cigarettes socially when out with friends I received smokers rates. I pay about $100.00 premium a month, I’m single, no kids, no girlfriend and I have a $1,000,000 life insurance policy. Just want an experts opinion, is this really a good choice for me? I already have life insurance through my job, and the extra $100.00 a month I’m paying in premiums could go into a roth IRA, my 401K or my portfolio… – Chad

  • John Bearss

    Hi Chad,

    Without knowing your entire financial situation, it is hard to say was is right and wrong. However, I will give some thoughts. First of all, if the life insurance is building a cash value, then this can be valuable money to you down the road because when you take a loan against the cash value it is not a taxable event. In the future what if:
    1. You leave your job and do not have the life insurance with them?
    2. What if you have a family later on in life?
    3. What if your health gets bad at some point and can not get life insurance in the future.
    Just some thoughts.

    If you decide against the life insurance the ROTH IRA is a good choice. It offers tax deferral and tax-free distributions as long as you play by the rules.

    I hope that helps.