Life insurance policies are more versatile than you might realize. Although many types of life insurance policies exist, all such polices share some basic commonalities. Life insurance policies are contracts between the insurance company and the insured. In exchange for a lump-sum or period payments, the insurance carrier agrees to pay a specific amount to beneficiaries if the insured dies while the policy is active.
Some life insurance policies provide benefits to the insured beyond loss protection. Whole life and universal life insurance policies incorporate a feature whereby the insurer invests part of the premium. This investment generates returns known as cash value. These are liquid funds that the insured may access during his or her lifetime. Many people tap life insurance cash values in times of economic hardship. Investment opportunity or major purchases are also common occurrences that prompt withdrawal. This approach has two major drawbacks, however.
Returns accumulated on cash values are compounded
Interest initially accumulated subsequently earns additional interest. Compounding results in much higher funds accumulation much faster than otherwise. Withdrawal lowers overall accumulation, as withdrawn funds are unavailable to earn interest. Withdrawal also attracts tax liability.
To avoid these consequences, many borrow against their cash values instead. By doing so, all funds remain intact for continued interest accrual. Moreover, no taxes are payable because the funds are borrowed. As loans advanced by the insurance carrier, interest is charged on the amount borrowed. Interest is typically much lower than that charged by other lenders, however. The loan is secured the insured’s own money! Such a scenario is very low-risk for the lender/insurer; thereby enabling the very low interest rate.
Cash value loans are more attractive than other loans
If the insured becomes unable to fully repay, he or she may reduce the monthly obligation by paying only the interest due. The insured may even elect to have outstanding interest deducted from the cash values. These loans are not reported to credit bureaus, so neither of these options damage the insured’s credit rating.
Defaulting on a cash value loan does entail some risks
If the insured dies before making full repayment, the outstanding balance is deducted from the death benefit. This reduces the amount paid to beneficiaries. If cash values are insufficient to meet outstanding interest while the insured lives, the policy lapses. In such an event, all loss protection and other policy benefits cease.
Overall, cash value loans are a practical option if you need liquid funds. They provide quick access without disturbing established assets or investment returns. You might find yourself very interested by the benefits they yield over time!