Using Life Insurance to Pay Off Debt in Your Lifetime
Yes, you can use life insurance to help pay off your debt – but only if you buy the right type of coverage. There are two main types of coverage: term life and permanent life insurance.
Term life: covers you for a specific period of time
Permanent life: covers you for the rest of your life, or until age 100
Only permanent life policies come with cash value. Cash value is like a savings account attached to your policy. It’s funded with a portion of every payment you make, plus interest paid by your insurer.
You can access that cash value in multiple ways:
Policy loans. This is a private loan between you and your insurer, letting you borrow against your cash value. It does not appear on your credit report. Like any loan, you will owe interest on the amount you borrow. If you don’t pay it back, the insurer will deduct what you owe from the death benefit before it pays out to your loved ones.
Partial withdrawals. If you don’t like the idea of a loan, you can withdraw a portion of your cash value. Instead of interest, however, you will probably have to pay a withdrawal fee. It’s likely to be less than the interest on a loan, however, so this may end up being the less expensive option.
Full withdrawals (when you cancel your policy). If you decide you don’t need your policy, you should always take the proper steps to cancel it – which means working through your insurer. If you have cash value at the time you cancel, you are entitled to a payout of that money, minus any outstanding loan balance and surrender (cancellation) fee.
Cash value is the best method for using life insurance to pay off debt in your lifetime – there are no restrictions on what you choose to use with the money. It’s yours to use as you see fit.
Tips and Considerations
Cash value is a great financial resource – use it wisely! Here are a few tips and considerations:
Cash value takes awhile to build up. It’s funded over time and isn’t going to be an instant source of cash as soon as you buy a policy. If you’re thinking of using life insurance to pay off debt in the first few years of your policy, it’s not going to be a viable solution. You just won’t have enough cash value yet. On the other hand, if you’ve had your policy for a decade or longer, there’s likely enough there to use to pay down a credit card, car payment, or make a lump sum payment toward your mortgage.
Different policy types accrue cash value in different ways. If you’re buying a policy just for the cash value benefits, pay close attention to the accrual method of the policy you choose. For example, whole life policies offer a flat, guaranteed rate of interest. If you can lock in a high rate of interest, this policy type is ideal for steady, dependable returns. But if you prefer to take a more active role, variable universal life lets you invest your cash value in a selection of market offerings. Stocks and ETFs are common options, depending on your insurer. The catch here is that just as you can earn cash value faster with good choices, a poor investment choice can cause you to lose cash value.
Policy loans let you earn more interest than withdrawals. If you’re debating between the two main methods to pull cash value, consider this. If you take a policy loan, yes, you owe interest – but it will be offset by the amount of interest you continue to earn on that cash value. Since you’re not actually removing any cash (just borrowing against it), the full dollar value is still in place and earning interest. With a withdrawal, money actually is leaving your account. Less money in your account means you’ll earn less interest going forward.