One of the advantages of having a universal life insurance policy over a term policy is the cash accumulation account. This cash account can build up thousands of dollars over years of paying for life insurance which adds to the death benefit in most cases. During tough times many people consider taking money out of their life insurance policy to help pay bills. I will discuss when it makes sense to withdraw from the cash value of a universal life policy and why you should not.
First you have to look at why you want to take the money out of the policy and there tend to be two reasons for most people:
- Need money for bills
- Potential of higher rate of return elsewhere
Should I pay bills with the cash value?
Most of the time when I get asked this question is when people are struggling with money. The policy may have a few thousand dollars in it and they need that money for bills. There are a few things you need to consider before withdrawing that money. First, the policy must be old enough so that there is little to no surrender charge for taking the money out.
This means that if the policy is within the first seven years on average there is a massive surrender charge as high as 90%. Be sure to know what the current surrender charge is and how much it will cost to withdraw your cash. It doesn't make much sense to withdraw money from the account if you can only get 10-50% out.
Should I take a loan from the life insurance policy?
Second, do you want to remove it all or just a portion of it. If you only want to withdraw a portion of the money it may make sense to take a loan from the policy for that amount. In this situation you would pay interest on the loan but not have to pay income tax on the amount withdrawn. On the other hand if you just want to withdraw the entire amount you would owe income tax on that amount over the principal investment. Basically any money that has come from interest is what you would owe income tax on. If you take all of the cash out of the policy the company will likely cancel that policy.
Higher ROI in another investment
The other argument to withdrawing money from the cash value of a life policy is the fact that there are other investment vehicles that tend to offer greater returns. Usually a universal life insurance policy will provide a 3-5% rate of return on the cash account. While there is no risk to this type of account because there is normally a guaranteed rate of return there are other investments that can return over 10 percent annually.
If you do plan to move the money to another investment be sure to know what surrender charges apply and how much income tax you will owe on the earnings. The policy is likely going to stop after the cash account is zero so be prepared to have other life insurance in place if needed.