6 Ways to Capture the Cash Value in Life Insurance

If you’ve heard it once, you’ve heard it a million times: Life insurance is a must-have, especially when you have a family that depends on your income. If you die unexpectedly, a life insurance plan will ensure your family’s financial needs are covered, from the monthly mortgage to grocery bills to your child’s college education.

While income replacement is the primary purpose of life insurance, many policyholders tap into cash-value life insurance for other reasons, such as building a nest egg for retirement. Also known as permanent life insurance, cash-value life insurance policies provide both a death benefit and a cash-value accumulation during the policyholder’s lifetime.

With cash-value policies, policyholders can use the cash value in a variety of ways including:

• A tax-sheltered investment;
• A means to pay policy premiums later in life;
• A benefit they can pass on to their heirs.

Whole life, variable life and universal life all have built-in cash value. Term life does not.

Far too many policyholders make the costly mistake of leaving behind a wad of cash value in their permanent life policies. When the policyholder dies, his or her beneficiaries receive the death benefit, and any remaining cash value goes back to the insurance company. In other words, they’re essentially throwing away that accumulated cash value.

Fortunately, you can take steps to ensure you don't trash your cash value. Here are six popular strategies to help you make the most of the cash value in your permanent life insurance.

If you have accumulated a sizable cash value over the life of your permanent life insurance policy and do not intend to use these funds yourself, you may choose to leave a larger death benefit to your beneficiaries. How can you pull that off? It’s usually very simple. Just call your life insurance company and say you’re interested in making a trade: You’d like to increase the death benefit in exchange for the cash value on your policy. Because the company doesn’t want to lose your business, it will more than likely accept your request.

During the trade, your objective should be to completely drain the cash value and transfer the full amount over to the death benefit or the face value. For example, if you have a universal life insurance policy with a $200,000 death benefit and $100,000 in cash value, your goal is to completely empty the cash value and boost the death benefit to $300,000. That’s $100,000 more that will fall into your heirs' hands instead of going to the life insurance company.

Once you have accumulated enough cash value, you can tap into it to cover premium payments. This is known as being “paid up.” The vast majority of life insurance companies are willing to honor this request—all you have to do is ask. Using this tactic, you could save $2,000 or more in premiums each year.

If you’ve built up a sizable cash value, you may also choose to take out a loan against your policy. Life insurance companies often offer these cash-value loans at interest rates lower than a traditional bank loan. Of course, you’re not obligated to pay back the loan since you’re essentially borrowing your own money. However, it’s important to note that any money you borrow, plus interest, will be deducted from the death benefit when you die.

If you’re low on funds or simply want to make a large purchase, you have the option to withdraw some or all of your cash value. Depending on your policy and the size of your cash value, such a withdrawal could chip away at your death benefit or even wipe it out altogether. While some policies are reduced on a dollar-for-dollar basis with each withdrawal, others (such as some traditional whole life policies) actually reduce the death benefit by an amount greater than what you withdraw. Be sure to discuss this tactic with your insurance agent before you make any sudden moves.

In recent years, cash-value life insurance policies have become extremely popular with investors looking to supplement their retirement income. If you have accumulated a healthy cash value, you can use these funds in a variety of ways as an asset in your retirement portfolio. Often these funds are guaranteed to grow tax-deferred for many years, which could really beef up your nest egg.

Most advisors say policyholders should give their policy at least 10 to 15 years to grow before tapping into cash value for retirement income. Talk to your life insurance agent or financial advisor about whether this tactic is right for your situation.

Of course, you always have the option to surrender your policy and receive the accrued cash value. Before taking this route, it’s important to consider many factors. First and foremost, you’re relinquishing the death benefit when you surrender a life insurance policy, which means your heirs will receive nothing from the policy when you die. In most cases, you’ll also be charged surrender fees, which could greatly reduce your cash value.

Additionally, the cash you receive through the surrender is subject to income tax. If you have an outstanding loan balance against the policy, you could incur even more taxes.

Don't let the cash value accumulate in a permanent life insurance policy without deciding how you will use it. And make sure the cash value is drained and redeployed later in life.