Life Insurance: Withdrawing Money And Policy Loans

Life insurance is a vital financial safety net for your loved ones after you pass away. However, did you know that you can also access the cash in your life insurance policy while you're still alive?

There are two main types of life insurance: term life insurance and permanent life insurance. Term life insurance is typically more affordable and only provides a death benefit, while permanent life insurance offers both a death benefit and a cash value component. This cash value can be a significant advantage of permanent life insurance, as it can be used to supplement your income during retirement, cover college tuition, or fund other large purchases.

- Withdrawals: You can withdraw cash from your permanent life insurance policy, usually up to the amount you've paid in premiums, without paying taxes. However, this may reduce your death benefit.

- Loans: You can borrow money against the cash value of your policy, often with lower interest rates and more flexible repayment terms than traditional loans. Any unpaid balance will be deducted from your death benefit.

- Surrender: You can cancel your policy and receive the surrender value in cash, minus any fees. This option should be carefully considered as it results in the loss of life insurance coverage and a reduced payout for your beneficiaries.

- Premium payments: You may be able to use the cash value of your policy to pay your life insurance premiums, freeing up cash flow for other expenses.

- Selling the policy: You can sell your policy to a third party through a life settlement, receiving a lump sum that is greater than the cash value but less than the death benefit. The buyer will then take over premium payments and receive the death benefit when you pass away.

It's important to carefully weigh the pros and cons of each option and consider the potential impact on your death benefit and overall financial plan before deciding to access the cash value of your life insurance policy.

Cancelling a policy and receiving a cash payment

Cancelling a life insurance policy and receiving a cash payment is a significant decision that can arise from various reasons. It is essential to understand the process and the potential financial implications before proceeding with the cancellation. The steps involved in cancelling a life insurance policy and receiving a cash payment can vary depending on the type of policy you have. Here is an overview of the process for cancelling a permanent life insurance policy, such as whole life or universal life, and receiving a cash payment:

Understanding the Cash Value of Permanent Life Insurance Policies

Permanent life insurance policies, such as whole life or universal life, typically include a cash value component that grows over time as you pay your premiums. This cash value can be accessed or withdrawn while the policyholder is still alive. However, it is important to note that withdrawing money from the cash value will leave less for your heirs after your death.

Ways to Access the Cash Value

There are several ways to access the cash value of a permanent life insurance policy:

• Surrender or cancellation of the policy: You can cancel your life insurance policy and receive the surrender value, which is the cash value minus any applicable fees. However, this option will result in the loss of life insurance coverage, and your beneficiaries will not receive a death benefit. Surrender fees and taxes may also reduce the amount you receive.
• Withdrawal from the cash value: You can withdraw a portion of the cash value, usually without paying income taxes if the amount withdrawn is less than or equal to the amount you have paid into the policy. However, this will result in a reduction in the death benefit for your beneficiaries.
• Borrowing against the policy: You can borrow money from the insurer, using your policy as collateral. There are no credit checks or repayment timelines, and interest rates are typically lower than those for personal loans. However, if the loan is not repaid before the policyholder's death, the outstanding balance will be deducted from the death benefit.
• Using the cash value to pay premiums: You may be able to use the cash value to cover your premium payments, especially if you are facing financial challenges and want to keep the policy active.

Considerations Before Cancelling a Permanent Life Insurance Policy

Before cancelling a permanent life insurance policy and receiving a cash payment, it is important to consider the following:

• Surrender charges and fees: Cancelling a permanent life insurance policy may incur significant surrender charges, especially for newer policies. These fees are often deducted from the cash value you receive.
• Impact on beneficiaries: Cancelling the policy will result in the loss of life insurance coverage, and your beneficiaries will not receive a death benefit. Carefully consider the implications for your beneficiaries before making a decision.
• Financial needs and circumstances: Evaluate your current financial situation and the potential impact of cancelling the policy. If the death benefit is critical for your financial security or your dependents, consider alternatives such as selling the policy for a lump sum.
• Potential for policy sale: Instead of cancelling the policy, you may be able to sell it to a third party, known as a life settlement. This can allow you to recover some of the premiums paid. Consult a reputable broker to explore this option and understand the financial return.

Withdrawing cash from a permanent life policy

Withdrawing cash from a permanent life insurance policy can be done in several ways, each with its own pros and cons. Here is an overview of the different methods:

Withdrawing Funds

Withdrawing funds from the cash value of a permanent life insurance policy is a straightforward way to access cash. This option typically does not incur income taxes if the withdrawal amount does not exceed the total premiums paid into the policy. However, a potential disadvantage is that the death benefit for beneficiaries may be reduced, and this reduction could be greater than the amount withdrawn, depending on the specific terms of the policy. It is important to carefully review the policy or consult with an agent to understand the implications of withdrawing funds.

Surrendering the Policy

Surrendering the policy involves cancelling the life insurance coverage and receiving the surrender value, which is the cash value minus any applicable fees. This option provides a lump sum payment but comes with surrender charges, especially for newer policies. Additionally, the beneficiaries will not receive a death benefit, and the payout may be subject to income taxes if it exceeds the amount paid into the policy. Surrendering the policy should be considered carefully, especially if the beneficiaries still rely on the life insurance payout.

Borrowing Against the Policy

Borrowing against the policy allows the policyholder to take out a loan from the insurer, using the policy as collateral. This option usually does not require a credit check, and the interest rates tend to be lower than those of personal or home equity loans. The loan can be repaid on a flexible timetable, and any interest paid on the loan adds to the cash value. However, if the loan is not repaid before the policyholder's death, the outstanding balance will be deducted from the death benefit. Additionally, an outstanding loan may reduce the cash value growth over time.

Using Cash Value to Pay Premiums

The cash value of a permanent life insurance policy can be used to pay part or all of the policy premiums. This option helps free up cash flow for other expenses and is particularly useful for older policyholders who want to maintain their life insurance coverage while using retirement income for living expenses. However, using the cash value for premium payments may reduce the cash value available for other purposes and could potentially lead to a lapse in the policy if all funds are used.

Selling the Policy

Selling the life insurance policy to a third party, such as a life settlement company, is another option for accessing cash. The policyholder receives a lump sum payment that is greater than the cash surrender value but less than the death benefit. After the sale, the buyer becomes responsible for paying the insurance premiums and maintenance fees for the rest of the policyholder's life and receives the death benefit upon their death. However, selling the policy means that the policyholder's heirs will not receive a death benefit, and the proceeds from the sale may have tax implications and impact eligibility for certain programs. Additionally, selling a policy may be challenging for younger individuals or policies with a lower face value.

Borrowing against a policy

Borrowing against a life insurance policy is a quick and easy way to get cash in hand when you need it. However, it is important to note that you can only borrow against a permanent life insurance policy, such as whole life insurance or universal life insurance, that has a cash value component. Term life insurance, which is cheaper and more suitable for many people, does not have a cash value and therefore, you cannot borrow against it.

When you borrow against your life insurance policy, your insurer lends you the money and uses the cash in your policy as collateral. This means that the policy's cash value can continue to accumulate, but it's important to check with your insurance company how interest and any dividends will be determined and paid when you have an active loan. Policy loans do not affect your credit and there is no approval process or credit check since you are essentially borrowing from yourself. Additionally, the loan is not recognised by the IRS as income and remains tax-free as long as the policy stays active.

It is important to consider the potential risks and consequences of borrowing against your life insurance policy. Policy loans can create financial turmoil if not managed properly. If you don't make interest payments, your policy could lapse and the entire loan amount could become taxable. Additionally, if you pass away before repaying the loan, the loan amount and any interest owed will be deducted from the death benefit, reducing the payout to your beneficiaries.

Before taking out a policy loan, it is recommended to consult a financial advisor or estate planning attorney to fully understand the tax implications and potential impacts on your loved ones.

Using cash value to pay premiums

Using the cash value of a life insurance policy to pay premiums is one of several ways to tap into the cash value of permanent life insurance. Permanent life insurance policies such as whole life and universal life can accumulate cash value over time. This cash value can be used to pay premiums, among other things.

The cash value of a permanent life insurance policy grows over time as you pay your premiums. If your balance is large enough, you can use the cash value of your policy to pay for part or all of your premiums, freeing up space in your budget for other expenses. This can be particularly helpful if you are retired and need to reduce your monthly expenses but want to keep your policy in place.

However, it is important to note that using the cash value to pay premiums will reduce the cash value of your policy. If all the funds in your cash value account are used to pay premiums, your policy may lapse. Additionally, using the cash value to pay premiums may not leave cash available for other expenses.

Before deciding to use the cash value of your life insurance policy to pay premiums, it is important to carefully weigh your options and consider the potential consequences. Consulting a financial advisor can help you understand all the potential implications of accessing your cash value.

Selling a policy to a third party

Selling a life insurance policy to a third party is known as a life settlement. This is when the policyholder sells their policy to a third party and, in turn, receives a lump-sum cash payment. The third-party buyer then assumes responsibility for future premium payments and ownership of the death benefit.

The first step in selling your life insurance policy is identifying the right people to work with. You need experienced professionals who are properly licensed and knowledgeable about the necessary regulations and requirements.

The next step is to meet the minimum qualifying factors. These include:

• Owning a policy with a death benefit of $100,000 or more.
• Being over the age of 60 or 65.
• Having a decline in health from the time the policy was issued (although this is not always necessary).

If you meet the basic qualifying factors, you'll then complete a detailed health questionnaire and provide authorization for the provider to access your medical records and contact your insurance company.

The provider will then gather information about your policy and health to determine its market value. They will consider whether your policy is a good investment based on its value and the opinion of medical experts regarding your health.

If your policy is deemed suitable for purchase, the settlement company will make an offer, which you can accept or decline. It is recommended to compare offers from multiple companies before making a decision.

If you accept the offer, the settlement provider will send a closing package for you to review and sign. Once you return the signed documents, your insurance provider will be notified of the transaction, and ownership of the policy will change. You will then receive the settlement funds.

Pros and cons

There are several advantages to life settlements, especially if you're worried about not having enough money in retirement. However, there are also some potential drawbacks.

Pros

• You can stop paying premiums.
• You will receive more money than if you were to lapse or surrender your policy.
• You can use the money to pay for medical or long-term care expenses.
• You have the flexibility to spend the payout as you wish.

Cons

• Your beneficiaries will not receive the policy's death benefit.
• There may be potential tax liability.
• It may change your eligibility for Medicaid or other financial assistance.

Alternatives

Before selling your life insurance policy, it's worth considering the following alternatives:

• Use the cash value of the policy.
• Convert to a whole life insurance policy.
• Seek an accelerated death benefit.
• Change the beneficiary.
• Reduce the death benefit.
• Replace your policy.
• Surrender the policy.

Frequently asked questions