The next time you have a financial emergency, you might want to review the terms of your life insurance policy before whipping out your credit card.
Some life insurance policies not only pay out when you die, but they give you the option of tapping them for quick cash while you’re alive.
There are two basic types of life insurance policies. Term life insurance policies cover a specific period of time and pay out only if the person insured dies during that period. Permanent life insurance policies cover the insured person for his or her entire life. Permanent life insurance policies are costlier than term life policies, but a portion of the premium is saved or invested. That portion, known as the cash value, can be borrowed against or possibly withdrawn if you cancel the policy.
“A good life insurance policy is one of the best assets you can own,” says Gregory W. Albers, president of Leawood, Kansas-based Life Insurance Buyers. Albers should know. Back in 2000, when his business ran into financial difficulties, Albers borrowed about $15,000 against the cash value of his life insurance policy. Not only did the loan not impact his credit, but “the insurance company didn’t ask me what the money was for and in a week, a check arrived in my mailbox.”
A third way to get cash from a permanent life insurance policy is to sell it. Life insurance settlements are transactions in which life insurance policyholders sell a policy to an investor for an amount that’s higher than the cash value but lower than the death benefit. In return for the cash, the investor takes over the premium payments, but receives the death benefit when you die.
Weighing the pros and cons
While it pays to have options, “Make sure you’ve exhausted all opportunities before you tap your insurance policy for money or borrow from credit cards,” says Deanna Booker, communications and outreach manager for Consumer Credit Counseling Service of Maryland and Delaware.
However, if you need the money, here’s how the different options stack up:
Borrowing against a policy
The higher your insurance policy’s cash value, the more you can borrow. The interest rates are often lower than those charged by credit cards, according to the National Association of Insurance Commissioners (NAIC). Since you’re borrowing from yourself, there’s no credit check and the loan won’t show up on your credit report. Another benefit is a flexible payback schedule. You can pay the loan back whenever you want so there’s no monthly bill. A loan from your life insurance policy is typically not considered income by the Internal Revenue Service, so you also don’t have to pay taxes on it, the NAIC says.
However, if you die before paying back the loan, the outstanding amount plus any unpaid interest is subtracted from your death benefit, possibly leaving your survivors in a lurch.
It’s also important to note that accrued interest increases your loan balance so if you’re not making payments, your loan balance could eventually exceed your policy’s cash value. If that happens, your policy could lapse.To avoid that, at least pay enough to keep up with the interest and pay the entire loan off as soon as possible, suggests Ben G. Baldwin, author of “The Complete Book of Insurance: The Consumer’s Guide to Insuring Your Life, Health, Property and Income.”
|Sorting permanent life insurance options|
There are four types of permanent life insurance, all of which offer a cash value component.
Whole life insurance: Consumers pay a fixed premium as long as the policy is in effect; there’s a guaranteed annual cash value growth.
Universal life insurance: The policyholder can adjust the amount and timing of premium payments, as well as coverage levels. There’s a guaranteed annual cash value growth.
Variable life insurance: The policyholder has investment flexibility and can designate that the cash value be invested in stocks, bonds or money market accounts. There’s no guaranteed cash value growth because of changes in stock market conditions.
Variable universal life insurance: Policyholders can adjust the amount and timing of premium payments, as well as coverage amounts. Policyholders also have investment flexibility, but again, there is no guaranteed cash value growth because of changes in market conditions.
Canceling a policy
Canceling a life insurance policy to withdraw the cash value as a lump sum can be a good option if your life circumstances have changed and you no longer need the protections the policy affords you. For example, you may no longer have a spouse or young children to provide for, or you may have other financial assets in place for those purposes.
However, if that’s not the case, canceling a policy could be a bad move since “cost is then shifted onto your survivors in the event of your death,” says Baldwin. You may also be required to pay a surrender charge — a fee for terminating the policy — that eats into the amount of cash you receive.
If you cancel thinking that you’ll take out another policy later, keep in mind that the older you are, the more expensive life insurance costs. Deteriorating health conditions can also dramatically increase the amount you pay. “Know that you’ll likely never be able to buy insurance this cheap again,” says Albers.
Selling a policy
Since investors who’d be willing to buy your policy would be making money on your imminent death, this option is generally reserved for those without a long life expectancy, such as seniors and those who are terminally ill. It can provide much-needed cash quickly as long as the recipient won’t need the death benefit for burial purposes or to provide for family members.
Borrowing from a credit card
A promotional offer by a credit card could be a better deal than tapping a life insurance policy, particularly if you can pay the debt off before the interest rates go back to normal. Consumers who don’t have the self-discipline to pay back a loan against life insurance might also do better with a monthly credit card bill.
However, credit card loans can weigh heavily on your credit score. They also could wreck your budget since you’ll have another monthly financial obligation.
No matter which choice you make, weigh the pros and cons and remember that you could be sacrificing future financial stability by using any of these options to get cash, Booker says. “Budgeting for unexpected expenses is always best.”