Life Insurance Cash Redemption: What's The Real Deal?

Ordinary life insurance is a type of permanent life insurance that offers a death benefit and a cash value account, which grows over time. The cash value in an ordinary life insurance policy can be accessed in several ways, such as borrowing against the policy, withdrawing cash, or surrendering the policy. While borrowing against the policy or withdrawing cash can reduce the death benefit, surrendering the policy will result in the loss of the death benefit. It is important to carefully consider the options and potential consequences before accessing the cash value of an ordinary life insurance policy.

Borrowing against your life insurance policy

When borrowing against your life insurance policy, the insurance company lends you money, using the cash value of your policy as collateral. This means that the cash value continues to accumulate, but it is important to check with your insurance company how interest and dividends will be determined and paid. The loan is not recognised by the IRS as income and remains tax-free as long as the policy stays active. However, if the loan is not repaid, it will reduce the death benefit that your beneficiaries will receive.

The amount you can borrow against your life insurance policy depends on the insurer's rules and the cash value of the policy. In general, you can borrow up to 90% of the policy's cash value. It is important to note that borrowing against your life insurance policy is not risk-free. If the loan is not repaid, it may reduce the death benefit or cost you your policy. Additionally, interest is added to the loan balance, and if left unpaid, it can cause the policy to lapse. Therefore, it is crucial to make regular interest and premium payments to avoid these issues.

Before borrowing against your life insurance policy, it is recommended to consult a financial advisor or estate planning attorney to understand the tax implications and potential impacts on your beneficiaries.

Withdrawing cash from your policy

If you have a permanent life insurance policy, you can withdraw cash from it while you are alive. This is known as the cash value of your life insurance policy. The cash value is a savings component that accumulates over time as you pay premiums. The cash value of your life insurance policy can be used for various purposes, including withdrawing cash, borrowing cash, or paying policy premiums.

• Partial Withdrawals: You can usually make partial withdrawals from your policy, but this will reduce the death benefit. The amount available for withdrawal depends on the type of policy and the insurance company. Some policies allow unlimited withdrawals, while others restrict the number or amount that can be withdrawn.
• Tax Implications: Withdrawing cash from your life insurance policy may have tax implications. If you withdraw more than the total amount of premiums you have paid into the policy, the gains from dividends or interest may be taxed as ordinary income. It's important to consult a tax advisor to understand the tax implications for your specific situation.
• Impact on Death Benefit: Withdrawing cash from your policy will generally result in a reduction in the death benefit that your beneficiaries will receive. In some cases, the reduction may be more than the amount you withdraw. It's important to carefully consider the impact on the death benefit before making any withdrawals.
• Surrendering the Policy: If you decide to cancel or surrender your policy, you can withdraw the accumulated cash value, minus any surrender charges and unpaid premiums or outstanding loan balances. However, by surrendering the policy, you give up the right to the death benefit, and replacing the lost benefit later may be more complicated or expensive.
• Loan Options: Instead of withdrawing cash directly, you may be able to borrow money from the insurance company using your cash value as collateral. This option allows you to access cash while keeping your policy in force. However, the loan amount will generally accrue interest, and the outstanding loan balance will reduce the death benefit for your beneficiaries.
• Financial Considerations: Withdrawing cash from your life insurance policy can have financial implications beyond taxes and the reduced death benefit. It may affect your long-term financial goals and your ability to maintain the policy, especially if you need to increase your premiums to maintain the same level of coverage.
• Alternative Options: Before withdrawing cash from your life insurance policy, consider other options such as borrowing against your 401(k) plan, taking out a home equity loan, or selling your insurance policy (if allowed). These alternatives may provide better financial outcomes while still giving you access to the cash you need.

Surrendering your policy

The cash surrender value is the cash value minus any fees charged by your insurance company, as well as any unpaid premiums or outstanding loan balances. Surrender fees and taxes may also apply, which could reduce the amount you receive. These charges vary depending on how long you've had the policy and the amount being surrendered. Surrender fees are usually higher for newer policies and don't apply after 10 to 15 years.

If you surrender your policy, you will no longer have life insurance coverage, so your beneficiary won't receive a death benefit. If you want to replace the lost death benefit later, getting the same coverage might be more complicated and expensive.

If your policy has accumulated a significant amount of funds in its cash value, you may be able to use that money to pay premiums, take out a loan, or withdraw cash permanently. If you withdraw enough, you will surrender the policy.

Before surrendering your policy, consider other options such as borrowing against your 401(k) plan or taking out a home equity loan. If you're thinking about surrendering your policy, contact your insurer to find out what your surrender value is and what fees apply.

Using cash value to pay premiums

Permanent life insurance policies such as whole life, universal life, and variable life can accumulate cash value over time. This cash value can be used to pay premiums, but it's important to note that the cash value of a policy is separate from the death benefit, so your beneficiaries will not receive the cash value when you pass away.

When you make a premium payment for cash value life insurance, the money is typically split into three categories: the cost of insurance, fees and overhead, and the cash value. The cash value of the policy is the portion of your premium payments that is invested and accumulates over time. This can be used to pay premiums, but it's important to carefully monitor the cash value to ensure it doesn't drop too low, as this could result in a loss of coverage.

Variable and universal life insurance policies are often favoured for this strategy because they allow policyholders to use the cash value to pay premiums. Whole life insurance policies typically do not let you pay premiums using the policy's cash value, except if you convert to a paid-up policy.

While using the cash value to pay premiums can be a useful strategy, it's important to consider the potential downsides. For example, if you withdraw more than you've paid into the policy, you may owe income taxes on the earnings. Additionally, withdrawing funds from the policy will likely result in a reduction in the death benefit. It's also important to weigh the opportunity cost of using the cash value to pay premiums instead of for other purposes, such as supplementing retirement income or funding a major expense.

Before making any decisions, it's recommended to consult a financial advisor to fully understand the potential consequences of accessing your cash value.

Selling your policy

Selling your life insurance policy is known as a life settlement. It is a way to get money for your unwanted policy, and you will get more money than if you surrender it back to the insurance company. Most types of policies qualify for a life settlement, even term life insurance policies.

The process of obtaining a life settlement involves selling a life insurance policy to a third-party buyer for a cash payout that is more than the policy's cash surrender value but less than the total face value of the policy. The buyer then becomes responsible for paying your insurance premiums and maintenance fees for the rest of your life and receives the death benefit when you pass away.

The steps for selling a life insurance policy for cash are as follows:

• Find an experienced life settlement provider.
• Meet the qualifying factors, such as owning a policy with a death benefit of $100,000 or more and being over 60 years old.
• Take a detailed health questionnaire.
• Provide authorization to the provider to access medical records and contact the insurance company.
• Share your policy details with the life settlement provider.
• Wait for the underwriting process to be completed.
• Complete the closing process, which involves transferring ownership of the policy and placing the settlement payment in escrow until the insurance company has verified the change of ownership.

It is important to note that the proceeds from a life settlement may be accessible by your creditors, and you may lose eligibility for certain public assistance benefits. Additionally, there may be tax implications, so it is recommended to speak with a financial advisor before pursuing a life settlement.

Frequently asked questions