Perhaps the most common question with regard to permanent life insurance policies is, “Can I borrow any of the cash value?” What is disconcerting is the fact that no one ever asks, “How will this affect my insurance policy?”
To keep things black and white, the answer is yes, it is possible to borrow from the cash value that accumulates within a permanent life insurance policy. However, it is essential that the policyholder understand the potential risks associated with borrowing from this account and how such a withdrawal may affect the policy in the future.
Cash value accumulates for a specific purpose, and it is in the best interest of anyone who owns a permanent life insurance policy to understand how and why this happens. In the beginning of the policy, the internal cost of the insurance is less than the premium charged to the policyholder. A percentage of the premium is essentially an overpayment, and that portion is held in the cash value account. As the years progress and the policyholder gets closer to their life expectancy, the internal cost of the insurance increases, meaning that less and less of the premium payment is an overpayment.
At some point during the life of the insurance policy, typically about 75% of the way between the purchase date and the insured person’s natural life expectancy, the premium payments are exactly equal the internal cost of the insurance. At that point, no more money will be going into the cash value account because the premium is equal to the actual costs of the policy. However, in the years following this point, the cost of insurance will continue to increase, sometimes quite dramatically, meaning that the premium paid by the policyholder is not enough to cover all the costs. Permanent life insurance policies are designed to then reverse the flow of the cash value account to fill the gap left by this underpayment.
If policyholder borrowed the cash value that would have been used to fill that gap, then the insured person is then responsible for making up the difference between their premium payment and the true cost of insurance at that time. These policyholders will see increases in their premium invoices.
Essentially, the cash value that accumulates in a permanent life insurance policy is designed as a method of escrowing future premium payments. At the time of purchase, the insurance company will calculate the premium required to pay the cost of insurance while also setting aside enough money to create reserves for future premium increases, thereby arriving at a fixed premium.
To sum it all up, cash value can be borrowed from a life insurance policy, but it is extremely important that those funds be replaced as soon as possible to avoid an increase in the monthly premium invoices and a risk to the stability of the insurance policy.