Signs life insurance can be tapped for cash
There are two basic types of life insurance: term plans, which provide coverage for a set number of years and usually offer a payout only if the policyholder dies during the term; and permanent policies such as whole, universal and variable life, which can provide a death benefit for as long as you live and also offer a savings component. While permanent plans are generally more expensive than term plans, a major perk is that often you can borrow from the savings reserve or cash it in. It's not always easy to tell if you can treat your policy as a piggy bank. These highlighted keywords and phrases in the sample policy below are giveaways that you can pull money from your life insurance.
Hover over the term to see its definition.
- Cash value: This is the formal term for the reserve that builds up in a permanent life insurance policy. The premiums are split two ways: Part of your money covers the actual cost of insurance, and part gets invested and accumulates value, tax-deferred, the longer you hold it. The cash value of a policy is determined by how long you've held the policy and how well the policy's investments are performing, says Keith Friedman, founder of FBO Strategies LLC, an insurance and estate planning firm in Stamford, Conn.
Rate of accumulation
- Rate of accumulation: Also called "rate of return," it's how fast your policy builds its cash value. Many policies come with guaranteed interest rates, meaning your policy will accrue value steadily for as long as you pay the premiums. Some variable and universal life policies tie their rates of accumulation to the plan's investments, says Damon Bates, a vice president at MassMutual insurance. Policyholders may earn more or less depending on how those investments perform.
- Policy dividend: It's a refund of a portion of your life insurance premiums that's paid when the insurance company's investments have had a good year. This potential spreading of the wealth is a feature of many policies, which might be borrowed from or cashed in.
- Surrender value: Before letting policyholders cash out, insurance companies deduct outstanding loans and may charge substantial surrender penalties. "Surrender value would be the amount of net cash value that you could cash in or surrender your policy for" after taking into account the various costs, says Bates. Surrender values are oftentimes significantly lower than the policy's true cash value.
- Loan value: This is the maximum amount that can be borrowed from a life insurance plan. Loan values can vary, depending on the type of policy, how long it has been in force and whether the policyholder has kept up with premiums, says Friedman. "Most carriers only allow you to borrow a percentage (of the policy's cash value or surrender value), usually up to 80 percent," he adds.