Building Cash Value: Maximizing Your Life Insurance Benefits

Cash value life insurance is a type of permanent life insurance that includes a cash value feature. This means that, in addition to the death benefit, there is a cash component that policyholders can access during their lifetime. This cash value typically accumulates over time and can be withdrawn or borrowed against to cover significant expenses. However, accessing the cash value will generally reduce the available cash surrender value and the death benefit. While cash value life insurance can be a useful tool for long-term savings, it is important to carefully consider the potential consequences of accessing the cash value, as it can impact the amount available to you and your beneficiaries.

Borrowing against cash value

Borrowing against the cash value of your life insurance policy can be a quick and easy way to get cash in hand when you need it. However, it is important to understand the risks and mechanics of this process before going ahead.

Firstly, it is important to note that you can only borrow against a permanent life insurance policy, such as a whole life or universal life insurance policy. Term life insurance, which is generally cheaper and more suitable for many people, does not have a cash value.

When you borrow against your life insurance policy, you are essentially borrowing from yourself, with the cash value of your policy acting as collateral. This means that there is no approval process or credit check, and you are free to use the money for anything you wish, whether that be bills, vacation expenses, or a financial emergency. The loan is also not recognised by the IRS as income and remains tax-free as long as the policy stays active.

However, it is important to understand that a policy loan will reduce your available cash value and death benefit. If you pass away while still owing money on a life insurance loan, the amount your beneficiaries receive will be reduced. Therefore, it is in your best interest to pay back the loan as soon as possible, on top of your regular premium payments, to avoid your loan exceeding your cash value and causing your policy to lapse.

Interest is added to the loan balance, and if left unpaid, your policy may lapse, and you may owe taxes on the amount borrowed. Insurance companies often provide many opportunities to keep the loan current and prevent lapsing, but if the loan is not paid back before the insured person's death, the loan amount, plus any interest owed, will be subtracted from the death benefit.

There are several other ways to access the cash value of your life insurance policy, including withdrawing cash, using it to pay policy premiums, or surrendering your policy for a cash payment. However, each of these options has its own set of pros and cons, and it is important to carefully consider the potential consequences of each before making a decision.

Withdrawing cash value

Understanding Cash Value in Life Insurance

Cash value life insurance, also known as permanent life insurance, includes a cash component on top of the death benefit. This cash value accumulates over time as a portion of your premium payments is allocated to it. The rate at which cash value grows depends on the type of policy, with whole life policies offering fixed rates and universal life policies depending on current interest rates and investments.

You can withdraw cash value from your permanent life insurance policy, but it's important to weigh your options carefully. Here are some things to keep in mind:

• Partial Withdrawals: You can typically withdraw limited amounts of cash from your policy. Withdrawals up to the amount you've paid in premiums are generally tax-free, but withdrawals above this amount may be taxed as ordinary income. Withdrawals will also likely result in a reduction of your death benefit.
• Full Withdrawal: If you withdraw the full amount of cash value, it will likely result in the surrender or cancellation of your policy. This means you will no longer have life insurance coverage, and your beneficiaries will not receive a death benefit. There may also be surrender fees and taxes that reduce the amount of cash you receive.
• Impact on Death Benefit: Withdrawing cash from your life insurance policy will almost always result in a reduction of the death benefit. This reduction may be greater than the amount withdrawn, depending on the specific terms of your policy. It's important to carefully review your policy or consult your insurance provider to understand the impact of withdrawals.
• Tax Implications: Withdrawing more than the amount you've paid in premiums may have tax implications. The portion of the withdrawal that exceeds your premium payments may be taxed as ordinary income. Consult a financial advisor or tax professional to understand the tax consequences of withdrawing cash value.
• Alternative Options: Before withdrawing cash value, consider other options such as taking out a loan against your policy, using the cash value to pay premiums, or exploring alternative sources of funding like home equity loans or personal loans. Weigh the pros and cons of each option to make an informed decision.

Remember, the specifics of withdrawing cash value may vary depending on your insurance provider and the type of policy you have. Always review the terms of your policy carefully and consult your insurance provider or a financial advisor before making any decisions.

Surrendering the policy

Surrendering a life insurance policy means telling the insurance company that you no longer want life insurance coverage. In exchange, the policyholder receives a portion of the cash value of the policy, known as the cash surrender value. This amount will generally be slightly less than the total amount of cash value in the policy because of surrender charges assessed by the policy.

There are several reasons why someone might choose to surrender their life insurance policy. One common reason is that the coverage is no longer needed. For example, if the policy's beneficiary passes away, there may be no other person to name as their replacement. Alternatively, if the policyholder is getting a divorce, they may want to get rid of the policy if their spouse was named as the beneficiary. Another scenario is that the policyholder's children, who were named as beneficiaries, are now adults who no longer need the coverage.

Another reason for surrendering a policy is to get the cash value. Surrendering a policy can be a valuable source of quick cash for someone who doesn’t have access to other liquid assets and needs the money immediately. However, it is important to note that there are alternatives to a cash value surrender that may pay more. For example, a life settlement involves selling your life insurance policy to a third party for more than the cash surrender value but less than the death benefit.

When considering surrendering a life insurance policy, it is important to understand the potential downsides. Firstly, if you surrender the policy during the early years of ownership, when the value is relatively low, the insurance company will likely charge surrender fees, reducing your cash value. These charges can be substantial during the first few years of the policy and may last for many years after the policy is issued. Secondly, when you surrender your policy for cash, the gain on the policy may be subject to income tax. Additionally, if you have an outstanding loan balance against the policy, you may incur further taxes. Finally, by surrendering the policy, you are giving up the right to the death benefit protection afforded by the insurance. Replacing this coverage later on may be more complicated or expensive.

Before surrendering a life insurance policy, it is recommended to explore other options such as borrowing against your 401(k) plan or taking out a home equity loan. It is also advisable to consult a financial advisor to understand the potential consequences of accessing your cash value.

Using cash value to pay premiums

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.

When you make a premium payment for cash value life insurance, it is split into three categories. One portion of your premium goes toward the death benefit, another goes toward the insurer's costs and profits, and the third contributes to the policy's cash value. In the early years of the policy, a higher percentage of your premium goes toward the cash value. Over time, the amount allotted to cash value decreases, and the amount allotted to insurance increases as the cost of insuring your life gets more expensive for the insurance company as you age.

The cash value of life insurance earns interest, and taxes are deferred on the accumulated earnings. While premiums are paid and interest accrues, the cash value builds over time. As the life insurance cash value increases, the insurance company's risk decreases, because the accumulated cash value offsets part of the insurer's liability.

If you build up enough money in your cash value account, you may be able to use your cash value to cover premium payments. If you're struggling to make the payments, this option could provide some relief so that you can keep the life insurance in force. Talk with your insurance agent to find out what rules apply.

It's important to note that any amount taken from your cash value account and not repaid before your death will reduce the death benefit paid to your beneficiary.

Selling the policy

Selling your life insurance policy can be a strategic way to unlock financial value, but it's important to understand the process and your options. There are two primary paths: a life settlement and a viatical settlement. Both allow you to sell your policy, but they serve different situations and offer varying payout amounts depending on your policy type and health condition.

Life Settlement

A life settlement is a process of selling your life insurance policy to a third-party buyer. It is designed for policyholders aged 65 or older who are experiencing a health decline. Life settlements are best suited for permanent policies that accumulate value over time and are in higher demand. Term policies can sometimes be sold, especially if they're convertible to permanent coverage.

In a life settlement, you usually receive more than the policy's cash surrender value but less than its full death benefit. This is because the buyer takes over the policy, including future premium payments, and expects a return on their investment. As the seller, you no longer have to make premium payments, but your family won't receive the life insurance benefits upon your death.

Viatical Settlement

A viatical settlement is specifically for those with a terminal illness and a life expectancy of less than 24 months. It generally offers a higher payout since buyers expect to collect the death benefit sooner. Payment amounts are regulated by state laws to ensure that terminally ill individuals receive a fair percentage of the policy's value.

Steps to Sell Your Life Insurance Policy

• Hire an independent advisor: An advisor with expertise in life settlements can provide an accurate appraisal of your policy's value, help you understand the tax implications, and guide you through the process.
• Find a reputable, licensed broker: A life settlement broker can help you get the best possible offer by finding the highest bidder. They operate in an auction-style environment and have a fiduciary duty to work in your best interests.
• Get multiple offers: If you don't want to use a broker, you can approach life settlement providers directly. However, this may result in lower offers since there's no competitive bidding process.
• Round up your paperwork: The selling process involves not just your policy but also your medical history. Potential buyers will require access to your medical records to assess your policy's value accurately.

Tax Considerations

When selling your life insurance policy, it's important to understand the tax implications. The tax treatment differs between viatical and life settlements and can affect your net proceeds.

For viatical settlements, the money you receive is usually tax-free. On the other hand, life settlements may be taxed as ordinary income or capital gains, depending on the portion of the sale amount that exceeds your cost basis and the cash value of the policy.

Additionally, selling your policy and converting it into cash might reduce the value of your taxable estate, which could lead to lower estate taxes for your heirs. Consulting a tax professional is advisable to navigate these considerations effectively.

Frequently asked questions