If you are buying a home, you know how expensive it can be. The median home price is about $200,000 in 2017 and rising quickly. In some markets, you will be hard-pressed to find a home for less than $500,000. A standard mortgage requires a 20% down payment. In a $200,000 home, this is $40,000. No small amount of money to save! Even though there are programs to help lower down payments, most people will need more than $10,000 to $20,000 in cash between the down payment, closing costs, and legal fees. Where will the money come from?
Life insurance can be a good source of money for a down payment. Some forms of life insurance have a cash value reservoir that grows over time. This reserve of cash can be taken out in the form of a loan, or taken out through a partial surrender of your policy. Term life insurance does not have a cash value and loans can not be taken from it. If you have a whole life insurance policy, variable life insurance policy, or universal life insurance policy, congratulations because your life insurance contract has value.
Can You Use It to Buy a Home?
Yes. The money can be used for any purpose including buying a home. The value of a life insurance policy belongs to the owner of the policy, and they are free to use it as they see fit. Often times a life insurance company will have restrictions on the percentage of cash that can be taken out in a loan, such as 90% of the total. Besides a down payment, the money could be used for anything such as medical expenses, a vacation, shopping, tuition, emergency funds, or even a charitable donation.
In these times of expensive real estate and low savings rates, life insurance is an excellent source of money to help purchase a home. Purchasing a home is an excellent way for people to build equity, participate in the price appreciation of the real estate market, and lock in their cost of housing for a long period of time. Rent can go up every year, but a mortgage is the same price for up to 30 years. At Life Ant, we advise most of our clients to purchase their own home as soon as they can reasonably handle the cost and responsibility, because of the long-term financial benefits.
How Do You Take the Money Out of the Policy?
This is relatively easy. Money can be borrowed from a life insurance policy in three ways. A loan, a partial surrender which is also called a withdrawal, and a full surrender. Each has costs and benefits, and which one you choose depends on if you need the life insurance coverage in the future and intend to replenish the money over time.
Take a Loan
If you still want life insurance coverage, you can take a loan. The loan does have interest due, which accrues over time. If you have a whole life insurance policy, it also will probably reduce your dividend payment. If you intend on keeping the policy for a long time it would be wise to pay the loan back as soon as you can. There is no term limit on the loan as long as you make the required premium and interest payments, so you are not obligated to pay it back in any particular time frame. Your death benefit will be reduced by the amount of the loan, so beware of the consequences. The upside is that you get to keep the policy. Remember, if insurability is a concern, you may not be able to get another life insurance policy that is affordable. A loan is a great way to keep your policy and get the cash value you need.
A loan also does not have any tax consequences as long as your policy stays in force. If you surrender your policy in the future (or if the policy collapses because you can no longer afford the premiums and interest payments on the loan), and you took out more money in the loan than the premium payments you put in, you may have tax consequences in this case. The loan itself will not be taxable however unless your policy is a MEC.
A Withdrawal or Partial Surrender
You can make a withdrawal, which is equivalent to partially surrendering your policy. The life insurance company will let you take the cash out of your policy, but it will reduce your death benefit by the amount of cash taken out. If you have a high cash value relative to your policy benefit, you will significantly impact your policy and the benefit to your beneficiaries. This is an option if you never intend to pay back the amount of money that you take out, but you still want to keep some life insurance coverage.
A partial surrender may result in surrender fees during the first years of the policy. Typically, the fees reduce every policy year until they finally hit 0. Make sure that you consult with your agent to understand if you are subject to any surrender charges or other additional fees or penalties. Typically, the life insurance company will require you to leave some cash in your policy, but it is usually a relatively small percentage of the total cash.
A withdrawal will have tax consequences if the amount of money you take out is more than the amount of money that you paid into the policy. An advantage of life insurance is that is taxed in a first in first out manner (FIFO), meaning you can take withdrawals tax-free up to the total premium paid and the first money out is tax-free. Only if your policy is a modified endowment contract are the first dollars out taxed, which is a LIFO tax methodology. If you have tax questions or concerns, check with your agent or tax professional.
A Full Surrender
If you want to access the full value of your policy, and you do not need to keep the life insurance policy in force, you can surrender your policy in full. If you do this your policy will be gone forever but you will be able to get the total cash value in the policy minus any surrender charges if applicable.
You will only have a tax implication if your policy value is greater than the amount of premiums paid into the policy. As always, consult your tax professional and agent if you have any tax-related questions.
How to Use a Life Insurance Policy to Save
A great feature of life insurance is that it can not only protect your beneficiaries from financial harm in the instance of death of the insured but also accrue a real value that can be accessed for cash and even collateralized for a loan. If you are interested in using a life insurance policy to help save money, you should consider a whole life policy.
As you put money into the policy each year, the cash value of your policy will increase. Your policy will also begin to pay out dividend payments. To help you save, you should either use these to increase more paid-up insurance, which will increase your dividend in subsequent years. You could also keep them as cash and save them in a separate account. At some point, your dividend payment will likely be large enough to cover the entire premium due to your policy. This will automatically increase the cash value over time as well.
If you are going to use a whole life policy as a savings tool, you need to make sure that you are holding the policy long enough for it to make sense. There are many ways to structure a whole life policy in terms of death benefit and premium paid in and dividend options. You will want your agent to run multiple illustrations after she understands what you are looking for. You will see how different structures affect the way that cash accrues in the policy. Typically, you will need to own the policy for at least 5 to 10 years before it makes sense to take withdrawals. If your savings time horizon is shorter, you will probably want to use another vehicle.
You can also use a universal life insurance policy or a variable life policy, but these are complex and the fees can be high. Generally, we advise clients to stay away from these unless they are wealthy and sophisticated. These types of policies have variable funding structures, and really work best when you put a lot of money in during the early policy years. If you have enough money to make a universal or variable policy make sense, you probably don’t need help saving for a house.