Should You Borrow Against Your Cash Value or Withdraw It?

blocks with money bags on them, stacked in pyramid shape, being examined with magnifying glass. borrow against

Are you wanting quick cash? Maybe you’re experiencing an unexpected expense or an opportunity. Or, perhaps you’ve just got an upcoming car payment that’s going to be difficult to meet. No matter the scenario, it’s a pretty common phenomenon. And when you want some cash, you’ve got to make a choice about where to access cash. Credit cards, retirement accounts (like a 401k), or even a home equity line of credit are all options. However, they may not be the most ideal options. 

Yet, would you believe that if you’ve been paying your whole life insurance premiums, you’ve actually been contributing to your savings all along? While you may buy your insurance for the death benefit, you also get to enjoy the living benefit of cash value. This is just one of manny reasons whole life is an efficient and powerful way to save. 

The question is, how do you access your cash? Should you take a loan out, or simply withdraw it? The answer may surprise you! 

It’s Simple to Withdraw

Withdrawing, after all, is what you would do at the bank. Yet simple does not always mean better. There is actually a long-term impact to withdrawing from your cash value that many people don’t consider. And how could they? Most financial institutions don’t really talk about the power of leverage. Cash is king, after all! 

Yet, when you simply withdraw cash and use it at face value, you lose out on that cash’s ability to compound. Furthermore, you cannot simply put the cashback into your life insurance policy. Once you’ve taken it out, that’s permanent. Sure, you can pay more premium and Paid-Up Additions and build it up, yet that’s simply playing catch-up.

Ultimately, when you withdraw from your policy, you have less cash to earn dividends and interest, and fewer funds to borrow against. Though, in some cases, there can be an advantage to sidestepping interest charges. (Though you may still owe some income taxes, depending on how much you take.)

Fortunately, Policy Loans Are ALSO Simple

Now, to talk about leverage. When you take a policy loan, you are actually using your cash value as collateral to take a loan from the insurance company. This is why we call it borrowing AGAINST your cash value. 

Through this method, you can have your money within about a week, and there are no qualifications to be eligible for a loan. This makes it relatively simple and effective to access your funds this way. 

So why take a loan? Because when you take a loan, your cash value can grow, uninterrupted. As you pay back the loan (on your own schedule), your cash value uncollateralizes and becomes available to use again. This means you can grow your pool of money, and access cash in terms that are often preferable to bank loans and credit cards. 

Most companies will loan policy owners up to 90% or more of their cash value balance, while the cash value still earns dividends. However, you must pay interest on the loan, which currently varies between 5-9%, depending on the mutual company.

In this post, we’ll give you our rules of thumb to help you decide which is right for you—a cash value withdrawal, or a whole life policy loan.

Managing Your Whole Life Policy for Maximum Benefit

The financial mainstream encourages people to avoid debt and “pay with cash.” So it might seem like a no-brainer to simply withdraw your funds rather than take a loan. Yet if you look at your whole financial picture and consider the potential future costs of this decision, you may see things differently.

Some Questions to Consider:

Do you have the means to pay a policy loan back?

If you have a steady income or job, policy loans make perfect sense. Even if it may take months or years to pay back, your loan, if you believe you can pay it, the loan is the way to go. That way, your cash value can continue to benefit from uninterrupted compounding growth. This is a perk that a regular savings account does not afford. 

And as the policy owner, you have a significant amount of control over your loan. While you cannot dictate the interest rate, you can control your repayment schedule completely, making it more flexible than a credit card or bank loan. So if you have the means to repay, a loan is a great option.

If you cannot conceive of paying back your loan because of a continuing lack of income, (perhaps you are no longer working), a withdrawal is almost always the best choice.

How old are you? What are your circumstances?

If you are 90 years old, and no one is depending on your death benefit, you can still take a policy loan. You can have this peace of mind because your death benefit will cover your outstanding balance.

However, if you are in your 70s or even in your spry 80s with limited income, you may be better off withdrawing rather than borrowing against your cash value. After all, a loan will continue to accrue interest. This can spiral if not paid. And if you live for 10, 20, or even 30 more years without paying loans, your policy could implode.

If you are younger, withdrawing is going to have a greater negative impact on your savings. As a general rule, we advise someone who is active and has sufficient income to pay off a policy loan to borrow against their whole life cash value rather than withdraw. However, if you feel you have limited prospects for future income sufficient to repay the loan (and don’t want your life insurance to lapse), withdrawal is the better option.

Is your need for money temporary?

If you need the money for a limited time only, a policy loan probably makes the most sense. You don’t want to compromise your long-term savings because of a temporary need, if possible. (Yet again, consider your age and circumstances.)

Are you using the money to create more money?

PEM founder, Kim Butler, was interviewed on the popular Real Estate Guys about how whole life insurance makes a great companion to real estate investing, because it’s an ideal vehicle to provide short-term cash for investments. With real estate investing (and many other businesses), you can have short-term cash flow needs, and be able to use that money to generate a return, which allows you to pay off what you have borrowed.

We even have clients that borrow against their cash value to make short-term, fixed-rate loans secured against real estate or other assets that can bring them returns MUCH higher than their cost of obtaining the money through the policy loan. (This should only be done very cautiously, but can be a powerful wealth-building strategy when carefully considered.)

Have you measured and considered your opportunity costs?

When making a major purchase, such as a new roof or a new car, many policy owners actually strategize intentionally to borrow against their life insurance cash value. In this way, they minimize the opportunity cost of paying cash.

We are trained to measure interest paid on debts, yet learn very little about opportunity cost. This concept helps you identify interest not earned when you save in a bank and pay cash, rather than storing that money where it can grow. Opportunity cost is every bit as important to measure as the interest you’re paying (if not more so). We either “pay up or pass up” interest, and it is critical to have MORE MONEY working for you than less money, even if it creates temporary debts in the process.

Advantages to Borrowing Against

Some “pros” to using a policy loan are:

  • Your cash value keeps growing, even while you’re “using” it. The dividends and interest you can earn help offset any interest you pay. When you withdraw money, that’s it, it can’t grow. 
  • There are no qualifications required for your loan, other than having the cash value to borrow against.
  • You can pay back the loan on your own schedule, fast or slow, steadily, or in a lump sum. This gives you flexibility where banks and credit cards have none. 
  • You pay interest annually, in advance. And if the loan is paid back early, you will receive a refund for the “overpaid” interest.
  • Loans are tax-free (as long as your policy remains in force, and you repay your loans eventually).
  • Policy loans do not affect your credit and are not tracked by the IRS, credit reporting agencies, banks, or anyone other than you and your insurance company.
  • Should you find yourself unable to pay the loan, you can still pay for it with your cash value. You just liquidate that part of the asset and erase the loan.

What Are the Disadvantages?

The main disadvantage to policy loans is, obviously, the interest. Interest rates currently being charged for whole life policy loans are between 5 and 9%. And contrary to common urban legends, you do NOT pay the interest “to yourself.” At least, you’re not doing so directly. 

Instead, the interest you pay goes to the insurance company (who services your loan). The interest you and all policy owners pay to the insurance company benefits the company. And as a policy owner, it benefits you, since they pay profits to policy owners. (A whole life company is a mutual insurance company and is structured more like a cooperative than a corporation with stockholders.)

The main advantage of withdrawals is simple—you don’t have to pay it back! It’s your money, and you are free to take it without penalty or taxes (yet only up to your basis).

Cautions About Withdrawals

Some reasons you might not want to withdraw from your policy (if you can help it) include:

  • Withdrawals are treated as taxable income if you take more out than what you put in to the policy. If you withdraw repeatedly, you risk creating taxable events.
  • Withdrawals reduce your current and future dividends because it reduces your cash value. Your dividends are based on your cash value amount.
  • When you withdraw money, you cannot “put it back.” That is simply the rule of insurance. You can pay NEW premium and earn NEW cash value. However, you cannot “put back” withdrawn money into your cash value.
  • Withdrawals, as well as unpaid policy loans, reduce your death benefit. (This is not a terrible thing in most cases, as a properly set up policy will have an escalating death benefit over time.)
  • Interest continues to accrue on unpaid policy loans. If you have no plan to repay, and you expect to live decades longer, withdrawing is a better option.

Which is the Best Option for You?

It is essential to consult with a life insurance specialist before purchasing your cash value life insurance policy and they can help you construct your policy to meet your goals and objectives when it comes to taxes, death benefit payouts, income, even how you may wish to use policy loans.To speak with an advisor who is well-versed in life insurance, contact us today. We can put you in touch with a Prosperity Economics™ Advisor.

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