Is Borrowing Cash from Life Insurance a Good Idea?
Money has been tight for a lot of families this year due to inflation, leaving many to turn to different options in search of additional funds to get by. While some have been forced to use credit cards to fill the gaps, others have taken withdrawals from their 401(k) or even borrowed from their life insurance plan — the latter of which can be one of the better options, according to Forbes.
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The latest Consumer Price Index, released mid-September, showed the total increase for all goods the CPI tracks (like groceries, utilities, medical care) is 8.2% year over year, one of the highest spikes in decades. However, salaries have not kept up in the same way. As CBS reported, citing a survey from Bankrate, 55% of Americans say their earnings are not keeping pace.
Experts have suggested that some ways in which individuals are choosing to pursue the money they need to get by are more favorable than others. It’s ideal to find options besides credit cards since they only increase the debts you’ll need to pay off. And as GOBankingRates previously reported, avoiding early withdrawal from retirement savings will prevent penalties and taxes if you’re under 59-and-a-half years of age. Retirement savings is also vital funding you’ll need later in life.
Forbes suggests borrowing money from the cash value of a life insurance policy “can be one of the most convenient, low-cost financing options out there.” Most of the time, permanent life insurance policies (whole, universal and variable life options) will offer this opportunity. That’s unlike term life insurance plans that are lower cost in nature and protect people during certain times of life like when they are working or paying off a mortgage.
The reason permanent life policies are different, per Forbes, is they “build cash value as you pay the premiums. The cash value portion of the policy either earns interest or is tied to an investment account or index, allowing you to grow the money over time.”
If you do choose to take a direct loan, it works by letting you borrow from yourself, essentially. Almost like a cash advance. The vested amount in your account works as the collateral so you won’t need to pay taxes on the loan, which is a huge benefit. Nor will your credit be checked to be approved. Though, the insurance company will charge interest — but again, the benefit here is that it’s nominal and can sometimes be as low as 0.25% or 0% in some cases. If you pay it all back before you pass away, it won’t be taken out of the final life insurance payout given to your beneficiaries.
When it comes to the amount you can take out, that’s also a big advantage, as it can be nearly 95% of the cash value that’s allowed, though every insurance company has different guidelines. The other bonus is “you can take as long as you need” to pay it back, according to Forbes. Of course, interest will accumulate.
While it may sound foolproof, there are a few drawbacks. One, you can only borrow the amount of the cash value. So, if your policy is for $50,000 but you only have $5,000 in cash value, that’s what you can borrow. Even then, some insurance companies might limit it so you won’t be able to do the full $5,000. And if you don’t pay it back in a timely manner, you’ll be paying back more interest than might want to.
Some other options include surrendering the policy if you think you don’t need it anymore (perhaps if you don’t have dependents), or making a cash withdrawal instead — up to the amount of the premiums you have paid, though there is likely a fee involved and it will reduce the amount your policy will be worth.
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