Life Insurance Cash Value: Rollover To Annuity?

Life insurance and annuities are both insurance products that allow individuals to invest on a tax-deferred basis. While life insurance pays an individual's loved ones after they die, annuities take payments upfront and turn them into future income, including the option of guaranteed income for life. Some life insurance policies, such as whole life or universal life, have a cash value feature in addition to the death benefit. This cash value can be rolled over into an annuity, which will then invest and generate income based on the cash value balance. However, this involves giving up the life insurance death benefit for more income and investment guarantees.

How to roll life insurance cash value into an annuity

If you have a permanent life insurance policy, you may have built up a significant cash value over the years. This money can be tapped into in several ways, including rolling it over into an annuity.

How to Roll Over Life Insurance Cash Value into an Annuity

Firstly, it's important to note that you can only roll over your life insurance cash value into an annuity if your life insurance has cash value.

Step 1: Understand the Basics

When you roll over your life insurance cash value into an annuity, you are essentially investing the money and generating income based on your cash value balance. By doing this, you give up the life insurance death benefit in exchange for more income and investment guarantees.

Step 2: Understand the Tax Implications

According to Section 1035 of the tax code, you can roll over the cash value of your life insurance policy into an annuity tax-free. However, you will have to pay taxes on a portion of each payout, based on the proportion of your basis to your gains.

Step 3: Shop Around for an Annuity Provider

It is important to shop around for the annuity provider that offers the largest payout, as there can be a significant disparity among companies. You can compare payouts online or seek the help of a financial planner with experience in the insurance industry.

Step 4: Understand the Annuity Contract

When you purchase an annuity, you are buying a type of insurance contract designed to turn your money into future income payments. You can buy an annuity with either a lump-sum payment or multiple payments over time. You can also set up the annuity with a growth period to build your savings. The return on your investment will depend on the type of annuity you choose.

Step 5: Consider the Trade-Offs

By rolling over your life insurance cash value into an annuity, you are giving up the death benefit of your life insurance policy. This means that your heirs will not receive a tax-free lump sum upon your death. Instead, they will receive smaller annuity death benefits, on which they will owe income tax.

Additionally, annuities lock up your money for years and often come with considerable annual fees and surrender charges if you cancel early. Therefore, it is important to consider the trade-offs and discuss them with a financial advisor before making any decisions.

Tax implications of rolling life insurance cash value into an annuity

When considering rolling over your life insurance cash value into an annuity, it is important to understand the potential tax implications to ensure you don't get caught out.

Firstly, it is important to note that you can only convert your life insurance to an annuity if your life insurance has cash value. By converting, you give up the life insurance death benefit for more income and investment guarantees.

In terms of tax, if you have a profit (i.e., the cash value exceeds the premiums you paid), then the excess amount will be taxable. If you have a loss (i.e., the cash value is less than the total premiums paid), then you will not be able to take advantage of any tax benefits.

However, if you convert your life insurance cash value into an annuity through a 1035 exchange, you can do so without paying taxes on your gains. You will, however, have to give up the death benefit. You will then be taxed on a portion of each payout, based on the proportion of your basis to your gains.

If you withdraw your cash value, you can generally do so tax-free up to the amount of the total premiums you've paid. However, if you withdraw any gains, such as dividends, these will be taxed as ordinary income.

If you take out a loan against your cash value, this generally won't be taxable. However, if the policy terminates before you've repaid the loan, it may be taxed.

It is always recommended to consult a tax advisor or insurance professional to understand the specific rules and tax implications for your situation.

Pros and cons of rolling life insurance cash value into an annuity

Yes, you can roll your life insurance cash value into an annuity. This is known as a 1035 exchange, and it allows you to convert your life insurance into an income annuity without paying taxes on your gains. However, you will give up the death benefit associated with your life insurance policy.

Pros of rolling life insurance cash value into an annuity:

• You can lock in income for the rest of your life or a specific number of years.
• You no longer have to pay premiums.
• You can use the loss on the insurance policy to shelter future gains from the annuity.
• You can avoid paying taxes on your gains until the gains are distributed.
• Annuities offer better investment and income benefits while you’re alive, as your return is higher because you aren’t also paying for life insurance coverage.
• Annuities offer more income options, such as guaranteed income for life, which life insurance does not.

Cons of rolling life insurance cash value into an annuity:

• You give up the death benefit associated with your life insurance policy.
• Annuities can have costly surrender charges if you cancel early.
• Annuities lock up your money for years.
• Annuities can come with considerable annual fees for their investment and income guarantees.
• Annuities based on stock market investments can be complicated and difficult to understand.
• Annuity death benefits are smaller relative to life insurance.
• Your heirs would owe income tax on your annuity investment earnings.

Step-by-step process of rolling life insurance cash value into an annuity

Yes, you can roll your life insurance cash value into an annuity. Here is a step-by-step guide on how to do it:

Step 1: Understand the Basics

Before proceeding, it is important to understand the difference between life insurance and an annuity. Life insurance is primarily used to pay your heirs when you pass away, while an annuity is designed to grow your savings and pay you an income while you are still alive. Both have their own pros and cons, so it is essential to weigh your options carefully.

Step 2: Evaluate Your Needs

Ask yourself if you still need life insurance coverage. If your insurance needs have changed due to increased wealth, divorce, or a spouse's death, you may no longer need the same level of coverage. Additionally, consider the tax implications of any withdrawals or surrenders you make on your life insurance policy, as these can impact your decision.

Step 3: Choose the Right Annuity

When choosing an annuity, look for options with low expenses and low commissions. Avoid annuities with surrender penalties, which can be costly if you need to withdraw your money early. Compare different annuity providers to find the one that offers the largest payout.

Step 4: Understand the Tax Implications

When you roll over your life insurance cash value to an annuity, you can do so tax-free through a 1035 exchange. However, you will give up the death benefit associated with your life insurance policy. Additionally, you will pay taxes on a portion of each payout, based on the proportion of your basis to your gains.

Step 5: Consult Professionals

Before making any decisions, it is always recommended to consult a financial planner or advisor with experience in insurance products. They can help you navigate the complex world of insurance and ensure you make the right choice for your specific situation.

Alternatives to rolling life insurance cash value into an annuity

There are several alternatives to rolling life insurance cash value into an annuity. Here are some options:

Partial Withdrawals, Policy Loans, or Surrendering the Policy

You can access the cash value of your life insurance policy through partial withdrawals or policy loans. Withdrawing up to the amount you paid in premiums can be done tax-free, but withdrawals beyond that will be taxed as ordinary income. Borrowing against your policy is another option, as the loan is typically interest-only and can be repaid at any time. However, if the loan and interest are not repaid before your death, they will be deducted from the death benefit. Surrendering or cashing in the policy will also give you access to the cash value, but there may be tax implications, and your loved ones will lose the death benefit.

Trading Your Policy for a Long-Term-Care Policy

You can exchange your life insurance policy for a long-term-care policy tax-free. This option can provide coverage for long-term care expenses without incurring additional taxes on your gains. However, few long-term-care insurers allow lump-sum payments, so you may need to arrange partial exchanges annually to pay the premiums.

Selling Your Policy to a Life-Settlement Company

If you no longer need your life insurance policy and are looking for a lump sum of cash, you can sell your policy to a life-settlement company. These companies will continue to pay the premiums and collect the death benefit when you pass away. The size of the settlement will depend on factors such as the size of the premiums and your life expectancy. However, this option may not be suitable for younger and healthier individuals, as investors are primarily interested in policyholders who are older or have serious illnesses.

Rolling Over the Cash Value to Another Life Insurance Policy

If you still need some level of life insurance protection but want to reduce your costs, you can roll over the cash value to another policy. This option allows you to purchase term insurance for the amount of coverage you need, which typically has lower premiums than whole life insurance. The rolled-over cash value can then be used to fund your retirement or other financial goals.

Donating Your Policy to Charity

Donating your life insurance policy to charity is another alternative. By transferring ownership of the policy, you may be able to claim a tax deduction based on the total premiums paid. The charity names itself as the beneficiary and will receive the death benefit when you pass away.

Frequently asked questions