There's a tendency among financial writers to deride traditional whole-life policies and other forms of permanent life insurance. Conventional wisdom says it's better to buy term life and invest the money you've saved on premiums in something else. While there's a lot of truth in that, permanent life insurance can be a useful product when used correctly. That's especially true for policies that have been in force long enough to accumulate significant cash value. In time of need, you can easily borrow from or against your policy.
How Cash Accumulates
It's helpful to think about the difference between permanent and term life insurance as being much like the difference between buying and renting a home. There will be times in your life when renting is the more practical option, and the same holds true for term insurance. However, permanent insurance is a tangible asset that will increase over time, while term insurance just goes away when the term is over. As with a mortgage, your insurance premiums mostly cover costs for the first several years. Then, after 12 to 15 years, the policy begins building cash value.
Borrowing Against Your Policy
Once your insurance policy has a useful amount of cash value, you can use that as collateral for a loan. Your insurance company can provide you with a figure, called the cash surrender value, that tells you how much your policy is worth if you close it and take out the money. As long as your credit is generally sound, you can usually borrow an amount equivalent to that from a third-party vendor. That leaves all your policy's funds in place, to continue growing. The downside is that if you default on the loan you'll lose your insurance policy.
Borrowing From Your Policy
It often makes more sense to borrow from your insurance policy, instead. Insurers usually allow policyholders to borrow up to the full amount of accumulated cash value from their policies. It's your cash, so there's no approval process. Just ask for the forms, submit them, and the check will be on its way. It's not exactly free money, though. The company will charge you interest, and you'll lose the tax-sheltered growth of your cash value in the policy. Accumulated cash value can also pay the premiums to keep your policy in force if you're temporarily broke, and you'll lose that protection.
When It Works
It takes a long time for policies to accumulate any meaningful amount of cash, so if you've recently bought a whole life or universal life policy you won't be able to borrow much against it for years to come. On the other hand, if your granny bought a policy for you when you were an infant, that might just be your new best friend in time of need. Chances are the policy doesn't represent a significant part of your insurance protection, so you aren't risking much by using it for leverage. Just remember to thank your granny, afterwards.
Fred Decker is a trained chef and certified food-safety trainer. Decker wrote for the Saint John, New Brunswick Telegraph-Journal, and has been published in Canada's Hospitality and Foodservice magazine. He's held positions selling computers, insurance and mutual funds, and was educated at Memorial University of Newfoundland and the Northern Alberta Institute of Technology.