Always read the fine print

We should take some time to review a very important topic, which may not affect a wide range of people - but it can financially devastate those it does affect. The topic for today is life-insurance loans, particularly in the form of loans against the cash value. In our office, we see this in a variety of forms. The most common is with a variable, universal or variable/universal life-insurance policy. Any life-insurance policy which accumulates cash value may be borrowed against.

A traditional whole life insurance policy is not as likely to encounter problems, but problems can still arise. The most common scenario is with a variable, universal or variable/universal type of life-insurance policy. These policies provide returns on cash value by investing part of the premium in the stock market or investments tied to the stock market. While this may be attractive and is sometimes advertised as an investment, problems occur when the market underperforms.

A whole-life policy - on the other hand - will most often be tied to a standard rate of return, such as bank interest rates with guaranteed minimums. A loan against cash value in a whole-life policy is not necessarily foolproof, but it is less problematic than other types of policies. The problem arises when, over time, returns on the cash value are less than the accumulating loan interest. The loan balance - which is the principal and accrued interest - can outpace the growth of cash value. The risk is even greater when loan interest rates rise, such as we are seeing today. A second problem arises when the market underperforms and the cash value is insufficient to keep up with rising policy premiums.

The primary methods of intervening will be to pay at least the accumulating interest, make payments against the outstanding loan balance, pay off the loan entirely, or cancel the policy before it terminates on its own. R. Joseph Ritter, Jr. CFP® EA is the Executive Director of Zacchaeus Financial Counseling, Inc., a 501 (c) (3) nonprofit organization based in Lake Junaluska, which specializes in tax services and financial counseling and planning for low-and middle-income households.