Borrowing on Your Life Insurance
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Life insurance cash value: I just came across a chilling case that reminded me of why I don’t like permanent life insurance. Mr. Brown, an attorney, was told that he should have whole life. He could pay a few years of premiums and borrow the rest. The borrowing would be tax free and used to reduce the amount received upon his death. I bet many of you were told that by your agents. However, there is a catch.
The problem is that loans incurred an 8% interest charge. Eventually the amount of the interest accumulated caused a debt to exceed his surrender value. He thus cancelled his insurance. Here is what happened: He received an 1099 from the insurance company noting that he is taxable on almost $30,000,which is the difference between all the dividends and earnings over his premiums paid. Even worse, the Browns thought it was an error so didn’t report this amount on their tax return and eventually had to pay the taxes, interest on the taxes and a 20% underpayment penalty.
Bottom line: if your loans are starting to exceed your cash surrender value, it is very possible that the insurance company will cancel the policy and trigger these unfortunate consequences. You need to make sure that you definitely have enough cash to pay the premiums and to limit your loans.
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