In financially rocky times like these, having a stash of cash that you could tap into to offset unexpected costs created by a job loss, an illness or a change in your mortgage rates could be a lifesaver.
It's hard to find a reliable backstop to help cover these unfortunate life events, however. The stock market is unstable at best right now, tapping into your 401 (k) plan can incur undesirable tax penalties and no one wants to run up a big balance on their credit cards.
Believe it or not, your life insurance policy may end up being your lifeline in times of economic uncertainty, thanks to a mechanism in many policies known as a policy loan.
Life insurance offers a lot more than just a benefit to be paid out to your family in the event of your untimely demise. Many policies also have "living benefits," that is benefits that you can make use of while you're still alive. One of the more common living benefits of a life insurance policy is the policy loan. Your life insurance policy accumulates tax-deferred cash value over time, and some policies allow you to take out a loan equal to the amount of your policy's accumulated cash value.
These loans can help you pay for your child's education, help fund your retirement or cover unexpected needs such as buying a new car or covering medical bills.
To receive a policy loan, you'll need to have a life insurance policy that's old enough to have accrued some cash value. In general, a policy you've only had for a year or two won't have accrued enough cash value to make a loan possible.
Once you take the policy loan option, you'll have to decide whether and how to repay the loan. Some life insurance policies allow clients to take policy loans but don't force them to repay it. The amount of the loan is deducted from the policyholder's death benefit. For example, if you had a $100,000 whole life policy, but borrowed $10,000 from it in a policy loan without repaying it, when you died your family would receive only $90,000.
If you choose to pay back the loan, you'll have to pay interest on it. Life insurance companies invest the money they receive in order to have enough cash to meet the needs of their policyholders. When you take a policy loan, you take money from the pool of cash the company has to invest, therefore they charge you interest on the loan in order to get a little something back. Interest rates on policy loans formerly were low, but have increased in recent years. Check with your life insurance agent about the interest before taking out a policy loan.
In some cases the interest you pay on a life insurance policy loan may be tax-deductible. These circumstances include: the four of seven rule, which stipulates that interest is tax deductible so long as four out of seven annual premiums of a life insurance policy are not paid through borrowing; the $100 exception, which makes interest deductible so long as it doesn't exceed $100 per year; the unforeseen events exception, which makes interest deductible if the borrowing was the result of an unanticipated decrease in the borrower's income or increase in his or her financial obligations; and the trade or business exception, which makes interest deductible if the borrowing was done to finance a trade or business cost, such as providing collateral for a loan.
When deciding to take out a policy loan you should take into consideration the seriousness of your need versus the cons, such as having to repay the loan or the reduction in the policy's death benefit if you don't repay the loan. While there are no stipulations concerning what you may use a policy loan for, it's probably not wise to use it for something frivolous such as a vacation or expensive toys like a boat or jet ski. It's much wiser to save the policy loan option for true emergencies that pose a serious threat to your financial well-being.
Policy loans are an extremely useful option to have in times of economic crisis and uncertainty, and are definitely another selling point for life insurance. By having a policy in place, you can weather out any economic storm by use of the policy loan mechanism. While these loans should be carefully considered before being used, it is extremely nice to know that such a lifeline is available to help with emergency costs.
Knowing that you can tap your life insurance policy for funds in times of dire need gives you increased peace of mind, which is what life insurance is all about.