Money Matters

Cash Flow Strategies

There are various cash flow strategies available to individuals. If you need cash, you may want to consider alternatives such as a loan against your life insurance policy, receiving distributions from your IRA account, or a 401(k) loan. However, you should consider the advantages and disadvantages of each strategy before implementing one.

Life Insurance
If you own a whole life insurance policy, you can take out a loan directly from the insurance company against the cash value that has been accrued in the policy. Unlike savings instruments, where accessing the money eliminates the interest earned on those funds, the cash value on a life insurance policy continues to increase even when the cash value has been withdrawn through a policy loan. This loan is subject to interest, which is generally nondeductible. You can elect whether or not to pay back this loan. If you elect not to pay back the loan, then the unpaid balance and accrued interest will be subtracted from what the policy’s beneficiary receives at the death of the insured. There are no limits on what the loan can be used for.

Alternatively, you could pledge your life insurance policy as collateral for a bank loan. If you use the policy as collateral for a loan, you will have to pay it back based on the terms of the loan.

If you choose to surrender a policy and receive cash before the death of the insured, there may be a taxable event. Any gain on the policy would be subject to income tax. A gain would result if your cash surrender value is greater than your basis in the policy. Your basis is the amount of premiums you have paid into the policy, minus any prior dividends paid or previous withdrawals. Be aware that surrender charges may also apply when you withdraw from your policy.

Note, however, that if you own a term life insurance policy, you cannot take a loan against the policy because the policy does not carry any cash surrender value.

IRA's
If a taxpayer receives IRA distributions before the taxpayer is age 59 ½, they usually must pay an early distribution tax of 10%. However, a useful exception to the early distributions tax is the exception for substantially equal payments. To qualify under the substantially equal payment exception, the distributions must be part of a series of substantially equal payments made at least annually for the life, or life expectancy, of the individual.
Other exceptions to the early distribution tax include withdrawals for:

Medical expenses that are more than 7.5% of your adjusted gross income.
Medical insurance if you are unemployed.
Disability.
An inherited IRA.
Qualified higher education expenses paid to an eligible educational institution.
First time home purchase (up to $10,000).
Qualified Reservist distributions.

401(k) Loan
If your plan provides for loans, you can receive funds tax-free from your 401(k). You can borrow up to 50% of the fully-vested amount in your 401(k), limited to $50,000. The loan must be repaid within five years of the initial loan. However, the five-year repayment requirement does not apply if the loan is for the purchase of a residence. If you fail to repay the loan in this time period, you can be subject to the 10% penalty tax if you are under 59½ when you receive the distribution. These loans also incur interest. This interest is ordinarily not tax deductible.

If your plan provides for hardship distributions, you may qualify for a loan if you are facing a financial hardship such as medical bills, funeral expenses, taxes, or home foreclosure. Hardship withdrawals are limited to the amounts attributable to elective contributions to the plan. These hardship withdrawals are taxable distributions. Also, if you are under age 59½, you may be subject to a 10% addition to tax on premature distributions.



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