How Taking Cash From a Whole Life Policy Affects the Face Amount

Whole life insurance provides lifetime coverage along with a cash value savings component. This cash value can be accessed through withdrawals or policy loans while the insured is still living.

But dipping into the available cash affects the other key policy value – the death benefit and face amount. Reducing cash value can shrink the amount your beneficiaries would receive if you pass away.

In this comprehensive guide, we’ll explain how accessing cash value impacts the face amount of a whole life insurance policy. We’ll also discuss how to monitor these values and when tapping cash might make sense.

How Does Whole Life Insurance Work?

With whole life insurance, you pay set premiums and are covered with a guaranteed death benefit for your entire life – hence the name “whole life.”

The policy has two main components:

• Face amount – This is the death benefit. It’s the amount paid to your listed beneficiaries when you pass away.

• Cash value – A portion of your premiums go toward building up a cash value reserve that grows on a tax-deferred basis.

Many whole life policies accumulate cash value through dividends earned by the insurance company’s general investment account. These dividends can be taken as cash or used to buy additional insurance coverage.

You can also access cash directly via withdrawals or policy loans from the insurer. But this reduces your death benefit.

Why Access Cash Value From a Policy?

There are a few reasons a policyholder might withdraw or borrow cash from a whole life insurance plan:

• Supplement retirement income – The tax-advantaged cash can provide funds in retirement.

• Pay unexpected bills – The cash can help cover emergency costs without liquidating other assets.

• Pay policy premiums – Withdrawing cash value avoids out-of-pocket premium payments.

• Buy Paid-Up Additions (PUAs) – Some insurers let you use dividends to purchase additional coverage.

• Fund other goals – College costs, travel, starting a business, etc. The cash can help fund financial goals and opportunities.

How Do Withdrawals Impact the Face Amount?

When you make a withdrawal from the cash value bucket of your whole life policy, it directly reduces the face amount – dollar for dollar.

For example, say your policy has:

• $100,000 face amount

• $8,000 cash value

If you withdraw the full $8,000 cash balance, your death benefit drops to $92,000.

Most insurers let you withdraw a portion of the cash value. So if you took out just $4,000, your face amount would decrease to $96,000.

The reduction in face value also drops your future cash value growth. So withdrawals can have a compounding effect if done multiple times over many years.

How Do Policy Loans Impact the Face Amount?

Unlike withdrawals which permanently reduce face value, policy loans use your cash as collateral while keeping your full death benefit intact.

When you borrow from your cash value, the amount you take out is transferred to a loan account. Interest charges accrue on the loan balance each year (around 5-8%).

As long as you repay the loan (plus interest), there is no impact on the policy face amount. Your beneficiaries still receive the full original death benefit.

However, if the loan remains unpaid at the time you pass away, the insurer will deduct the loan balance plus interest from the death benefit before paying your beneficiaries.

For example, say you have:

• $200,000 face amount
• $50,000 cash value
• $10,000 loan balance at death

Your beneficiaries would receive the full $200,000 face amount, minus the $10,000 loan due, for a net payout of $190,000.

So ultimately unpaid policy loans reduce what your heirs receive. But loans give you access to cash value without permanently shrinking the face amount.

How to Track Your Policy’s Face Amount

It’s important to monitor your policy’s face value over time to ensure it still meets your intended needs. Here are some tips:

• Review annual statements for current face amount and cash value totals.

• Ask your insurance agent to explain any face amount changes year-to-year.

• Before withdrawing or borrowing, have your agent run projections showing the impact.

• If premium payments fall behind, request an update on how it affects the death benefit.

• Evaluate if additional Paid-Up Additions (PUAs) are worthwhile to boost the face value.

• Discuss options if you get off track – additional payments or new policy purchase.

Scenarios Showing Face Amount Changes

Here are some examples showing how real-world actions impact the face value on a whole life insurance policy over time:

Using Dividends and PUAs to Increase Face Value

• Initial policy with $250,000 face amount

• $2,500 annual dividends earned

• Dividends used each year to purchase Paid-Up Additions, increasing face value

• After 10 years, face amount grows to $300,000

Withdrawing Cash and Reducing Face Value

• Initial policy with $500,000 face amount and $15,000 cash value

• $10,000 withdrawal taken in year 1, reducing face amount to $490,000

• Another $5,000 withdrawal in year 3 brings face value down to $485,000

Borrowing and Repaying to Preserve Face Value

• Initial policy with $100,000 face amount and $8,000 cash value

• $4,000 loan taken out in year 1

• Interest accrues at 6% annually

• Insured repays full loan balance of $4,240 in year 5

• Face amount remains $100,000 throughout

Failing to Repay Loan Reduces Payout

• Initial policy with $750,000 face amount

• $200,000 loan taken and not repaid prior to death at end of year 20

• With accrued interest of $100,000, loan balance totals $300,000

• Net payout to beneficiaries is $750,000 (face amount) – $300,000 (loan due) = $450,000

Is Accessing Cash Value Worth It?

Depending on your financial situation and goals, tapping into your policy’s cash value via loans or withdrawals may make sense in some cases.

Reasons it can be beneficial include:

• Avoiding liquidating other assets or accounts to access funds

• Utilizing cash value for emergency expenses or unexpected bills

• Funding supplemental retirement income from the tax-advantaged source

• Paying policy premiums and keeping coverage active if money is tight

• Raising face amount through dividends and PUAs

Downsides to consider include:

• Permanently shrinking the death benefit when cash is withdrawn

• Owing loan interest charges that reduce eventual payout if not repaid

• Potential taxes and penalties if certain limits are exceeded

• Risk of policy lapsing if cash value is depleted too far

Discussing the scenarios with a financial advisor can provide guidance on pros, cons, and risks before utilizing cash value.

Monitoring Required Interest Rates for Loans

One important point – policy loan rates are not fixed. They are tied to a specific interest rate index and can adjust annually.

Insurers set a maximum cap on how high the loan rate can go. Common caps are in the 8-10% range.

The loan rate is based on the current values of the selected interest rate index, such as Moody’s Corporate Bond Yield Average or the ICE BofA US Industrial Development Bond index.

So it’s important to monitor the rate each year. Ask your agent if the interest rate index for your policy loan is rising. A dramatic jump could make servicing the loan difficult.

You may have options, such as choosing a different index, if the loan rate trend is moving higher than you anticipated.

Key Takeaways

• Withdrawing cash value from a whole life policy directly reduces the death benefit and face amount dollar-for-dollar.

• Policy loans allow you to access cash value without permanently shrinking the face amount unless they go unpaid.

• Monitor your policy values annually and ask your agent for projections before accessing cash.

• Weigh the benefits of policy loans or withdrawals against potential downsides.

• Consider all options if needing more cash, like dividends, Paid-Up Additions, additional payments, or a new policy.

The cash value within a whole life insurance plan provides useful flexibility. But withdrawals and loans can shrink the death benefit if not managed diligently. Planning carefully and evaluating all alternatives helps ensure the policy meets your long-term life insurance needs.