Financial Makeover: Cashing In

Most polices allow for the owner to borrow up to 95 percent of the CSV without having to prequalify or justify the need the need for the loan. Interest on the loan accrues (e.g., the owner does not actually need to make interest payments; the interest, instead, gets added to the outstanding loan balance) at an interest rate determined by the policy. Also, there is no requirement that the loan be repaid as long as the owner continues to pay the policy premiums and as long as the outstanding loan plus interest does not exceed the CSV. However, if the insured dies, the beneficiary of the policy receives the policy's face value less the total outstanding loan balance.

If the policy's loan interest rate is less than the interest rate James is paying on his other outstanding debt, it may be advantageous for James to borrow against the policy's CSV and use that money to pay down the higher costing debt. (When determining the cost of the other debt, James needs to remember that mortgage interest is deductible for income tax purposes so the actual cost of his mortgage is somewhat lower than the stated mortgage interest rate).

However, if James decides to follow this route, for the reasons mentioned above, he should make sure that he is able to repay the policy loan because his survivors will likely need the full amount of the insurance benefit paid by the policy.

Whether or not James decides to cash out the policy or borrow against it, he should only consider investing the available cash if he's very confidant that, over his investment time horizon, the rate of return on the investments will exceed the cost of the outstanding debt. If James is not confidant of this relationship, he should instead pay down his debt first, starting with the most expensive loans.

Need to get your finances in order? Apply for a makeover

Guest columnist Sandra Bragar, CFP, serves on the board of directors of the Financial Planning Association of San Francisco (www.fpasf.org) and is an associate planner with Kochis Fitz, a wealth-management firm in San Francisco (www.kochisfitz.com). Brager is also an instructor in the Personal Financial Planning program at the University of California-Berkeley Extension.