Many people scramble for ready sources of cash when an unexpected financial crunch hits. If you happen to own a whole life insurance policy, it likely has some cash value. The process of getting to the cash is usually pretty simple -- just a matter of filling out some forms and waiting for the check to arrive. How much you'll receive is more complicated.
How Whole Life Insurance Works
When you invest in a whole life policy, your premiums serve a few purposes. A portion goes toward the benefits your insurer will pay out to your beneficiary when you die. A smaller percentage goes to the insurance company for administrative costs. The balance goes to an investment fund that earns you money. These earnings go into your policy account. Depending on the type of whole life policy you choose, you may not know exactly how your insurer is investing the money for you. However, you should receive regular notification of the cash value of your policy -- how much all that investing has contributed to your policy account.
The Cash Value
If you've insured your life for $500,000, this is the face value of your policy -- the amount that goes to your beneficiary when you die. You won't get $500,000 when you cash it in, but the cash value -- however much you have in your cash-value account at that point in time. The longer you've had your policy, the greater the cash value is likely to be. Your insurer can deduct unpaid premiums, loans you've taken against your policy and haven't paid back yet, and possibly surrender fees. You receive what remains, but you no longer have life insurance if you surrender and cancel the policy rather than just accessing the cash in the account.
The growth of the cash value of your policy is tax-deferred as long as you leave the money with your insurer. If you cash out the policy, any amount of the cash-value account that exceeds the premiums you've paid is taxable as income. You can do a partial cash-out up to the amount you've paid in premiums without surrendering your policy, which is tax free. The amount of premiums you've paid is called your basis. If you exceed this, you'll lose a percentage of the money to the IRS.
Borrowing From the Policy Instead
Whole life policies offer another alternative if you really need to lay your hands on some money but you don't want to surrender your death benefits. You can borrow against the policy up to the amount of its cash value. The cash value acts as collateral, so there's no credit check involved. This isn't always possible in the first few years you've held the policy, but may be an alternative later on. The interest rates typically are lower than you'd pay for a bank or other loan. If you die before you pay the loan back, the balance is subtracted from the death benefits that go to your beneficiary.