Cashing In On Life Insurance: Early Redemption Options Explained

Life insurance is often taken out to provide financial security for loved ones after the policyholder's death. However, life insurance policies can also provide cash benefits to the policyholder while they are still alive. This is known as the policy's cash value. This value accumulates over time through interest or investment gains on a portion of the premiums paid by the policyholder. The cash value can be accessed in several ways, including withdrawing, borrowing, surrendering the policy, or selling it. While accessing this cash value can provide financial support, it is important to consider the long-term implications for the policyholder's finances and beneficiaries.

Withdrawing cash from a life insurance policy

Types of Life Insurance Policies

There are two main types of life insurance policies: term life insurance and permanent life insurance. Term life insurance is typically more affordable and provides coverage for a limited time, with no cash value component. On the other hand, permanent life insurance, including whole life, universal life, variable life, and indexed universal life insurance, offers lifelong coverage and includes a cash value account that can be accessed.

Building Cash Value

The cash value in a permanent life insurance policy takes time to build and may take several years before it becomes substantial enough to be useful. The cash value grows over time as a portion of the premiums paid goes into this account.

Withdrawing Cash

You can withdraw cash from your life insurance policy, usually up to the amount you've put in. This option is often called a "partial cash surrender." Withdrawals are generally not taxable if they don't exceed the total premiums paid. However, withdrawals may reduce the death benefit that your beneficiaries will receive.

Borrowing Against the Policy

Many life insurance policies allow you to borrow money against the cash value of the policy. This option typically doesn't require a credit check and offers flexible repayment terms. Interest rates on these loans are usually lower than personal or home equity loans. However, any unpaid balance will reduce the benefits that your beneficiaries receive.

Surrendering the Policy

You can choose to surrender or cancel your life insurance policy and receive the cash value, minus any surrender fees. This option terminates the policy, and your beneficiaries will not receive a death benefit. Surrendering the policy may also incur income tax on any earnings that exceed the total premiums paid.

Selling the Policy

Another option is to sell your life insurance policy to a third party or a life settlement company. This is known as a life settlement. You will receive a lump sum payment that is greater than the cash surrender value but less than the death benefit. The buyer will then take over premium payments and collect the death benefit upon your passing.

Considerations

Before withdrawing cash from your life insurance policy, carefully consider the potential impact on your future financial goals and your beneficiaries. Weigh the pros and cons of each option and consult with a financial advisor to make an informed decision. Additionally, review the terms and conditions of your specific policy, as details may vary.

Borrowing from a life insurance policy

If you have a permanent life insurance policy with a cash value, you can borrow against it by taking out a loan from your life insurance company. There is no approval process or credit check, and you can use the money for anything you want. The loan is also not recognised by the IRS as income and remains free from tax as long as the policy stays active.

However, there are a few things to keep in mind. Firstly, policy loans reduce the death benefit if not paid off. Secondly, life insurance companies add interest to the loan balance, which, if unpaid, can cause the policy to lapse. Therefore, it is important to pay back the loan in a timely manner, on top of your regular premium payments. If the loan is not paid back before the insured person's death, the loan amount and any interest owed will be subtracted from the death benefit.

The amount you can borrow against your life insurance policy depends on factors such as how much cash value has accumulated and the policy's terms and conditions. Generally, you can borrow up to 90% of the policy's cash value. However, it is important to note that it can take several years for the policy to accumulate enough cash value to borrow against.

Surrendering a life insurance policy

When you surrender your life insurance policy, you will receive a lump sum payment known as the cash surrender value. This is the total amount of cash value in the policy, minus any surrender fees or charges. Surrender fees can be substantial, especially during the early years of the policy, so it is generally not advantageous to cancel a new policy.

There are several alternatives to surrendering a life insurance policy that can provide access to cash while maintaining the policy. These include withdrawing money from the cash value, taking out a loan using the policy as collateral, or selling the policy through a life settlement. It is recommended to consider these options carefully and consult a financial professional before making any decisions.

Selling a life insurance policy

• Eligibility: To sell a life insurance policy, you generally must be 65 or older, or suffering from a serious illness that could soon take your life. Only term life policies that can be converted to permanent policies can be sold, and you must be the policy's owner.
• Value: The value you get from selling your policy will depend on factors such as your age, health status, the premiums you're paying, and the policy's death benefit. The older you are and the lower your life expectancy, the higher the offer is likely to be.
• Tax implications: The payment received from selling your life insurance policy may be taxable as income or capital gain. Consult a licensed tax attorney to understand your specific tax liability.
• Fees and commissions: Brokers or settlement companies will take a cut of the proceeds from the sale, typically around 30%.
• Impact on beneficiaries: Selling your life insurance policy could leave your beneficiaries with a lower or no payout when you pass away, affecting their financial security.
• Alternatives: There are alternatives to selling your policy, such as policy loans, partial surrender, accelerated death benefits, or converting to a paid-up policy.

If you decide to sell your life insurance policy, follow these steps:

• Understand how life insurance works and the specific details of your policy.
• Research your state's regulations on selling life insurance policies.
• Find a licensed life settlement broker or life insurance agent to help you seek multiple offers for your policy.
• Check the credentials of the settlement company or broker with regulatory sources.
• Take your time deciding—don't feel pressured to accept an offer.
• Once you accept a bid, transfer ownership of the policy to the buyer.

Using living benefits from a life insurance policy

Living benefits are features of a life insurance policy that can help and protect you while you're still alive. They are usually offered by permanent life insurance policies, which are more expensive than term life insurance policies. Living benefits allow you to build cash value that can be accessed while you are still alive. Here are some ways to use the living benefits from a life insurance policy:

Surrender the policy

You can surrender your life insurance policy and receive the full cash value, minus any surrender or cancellation fees. However, this will terminate the policy, and you will no longer have life insurance coverage. You may also have to pay taxes on any gains from the cash value.

Withdraw from the policy

You can withdraw cash from your permanent life insurance policy. This money is often non-taxable as long as it does not exceed the amount you've paid in premiums. However, withdrawing cash will likely reduce the death benefit.

Take out a loan

You can borrow money from your life insurance policy, using the cash value as collateral. You can choose not to repay the loan, but the outstanding balance and interest will be deducted from the death benefit. Borrowing from your life insurance policy can be a fast and easy way to get cash.

Pay your life insurance premium

You can use the money in your cash value to pay part or all of your premiums, making it easier to maintain your life insurance coverage.

Living benefit riders

Living benefit riders are additional coverage that can be added to your basic life insurance policy, providing supplementary benefits and protection. For example, an accelerated death benefit rider may pay out a portion of the death benefit if the insured is terminally ill. The money could be used for medical expenses, and the beneficiaries would receive a reduced life insurance benefit when the insured passes away.

Frequently asked questions