Life Insurance: Maximizing Your Policy For Peace Of Mind

Life insurance is often purchased to provide financial security for loved ones after the policyholder's death. However, life insurance policies can also be leveraged as a financial asset during the policyholder's lifetime. This strategy, known as premium financing or enhanced funding, involves adding leverage to a permanent life insurance policy to accelerate the growth of its cash value.

The cash value component of permanent life insurance policies grows over time and can be accessed by the policyholder while they are still alive. This provides an opportunity to leverage the policy as a source of funding. By borrowing against the cash value, policyholders can access funds for various purposes, such as supplementing retirement income, funding a house remodel, or paying for education.

There are different types of permanent life insurance policies that offer varying levels of flexibility and investment options. It is important for individuals to carefully consider their risk tolerance, investment knowledge, and financial goals when choosing a policy. Additionally, it is crucial to understand the potential consequences of accessing the cash value, as it can impact the death benefit and the account's growth.

Leveraging life insurance as a financial tool can provide individuals with increased financial flexibility and the potential for tax advantages. However, it is important to weigh the benefits against the risks and consult with financial advisors to make informed decisions.

Life insurance as a financial asset

Life insurance is not just a safety net for your loved ones; it can also be a valuable financial asset. Some life insurance policies can become a financial asset for you to use during your lifetime, much like an IRA or mutual fund. Permanent life insurance policies, for example, enable you to invest in conservative investments and allow the owner to build cash value over time. Here are some ways to leverage life insurance as a financial asset:

• Take a loan from your policy: You can borrow against the cash value of your permanent life insurance policy. However, it is important to read the fine print, as the interest rate can be fixed or variable, and it is set by the insurer. Additionally, if the loan is not paid off by the time of your death, any outstanding balance will be subtracted from what your beneficiaries receive.
• Use your policy as collateral for a loan: In some cases, you can use your life insurance policy as collateral for a loan, making it easier to get approved or get a better interest rate. However, if you pass away before repaying the loan, the outstanding balance will be deducted from your beneficiaries' benefit.
• Withdraw funds: You can make withdrawals from the cash value of your policy, which, unlike a loan, do not need to be repaid. However, if you withdraw an amount that exceeds your investment gains, you may have to pay taxes. Additionally, withdrawals will reduce the value of your policy and the death benefit for your beneficiaries.
• Option for "accelerated" benefits: Some policies allow you to receive benefits during your lifetime if you experience an unexpected or extreme medical emergency, such as cancer, a heart attack, or kidney failure. With these policies, you can usually withdraw a significant portion of your policy's value.
• Surrender the policy (cash out): If you no longer need life insurance coverage, you can cancel your policy and cash out the accumulated value. However, this will end your life insurance coverage, leaving your beneficiaries without financial protection.

It is important to note that not all life insurance policies are the same. If you are looking for a policy that can serve as a financial asset, choose one that has a cash value component. Permanent insurance policies, such as whole life insurance and universal life insurance, typically fall under this category, whereas term insurance policies do not offer the ability to grow money in an account that you can access.

Using life insurance as collateral for a loan

A collateral assignment of life insurance is a method of securing a loan by using a life insurance policy as collateral. This means that if you pass away before the loan is repaid, the lender can collect the outstanding loan balance from the death benefit of your life insurance policy. Any remaining funds from the death benefit would then be disbursed to the policy's designated beneficiary or beneficiaries.

Collateral assignment may be a useful option if you want to access funds without placing any of your assets, such as a car or house, at risk. It may also be a credible choice if your credit rating is not high, as lenders are more likely to offer favourable terms when they can rely on the policy's death benefit to pay off the loan if necessary.

The process of applying for a collateral assignment of life insurance is as follows:

• Know the requirements: Lenders generally require an active life insurance policy with cash value. This means that a term life insurance policy may not qualify. However, exact requirements vary by lender.
• Fill out a life insurance application: Apply for a life insurance policy that will meet the lender's loan requirements. Check with the lender to ensure that the policy qualifies for a life insurance collateral assignment before signing the contract.
• Fill out a collateral assignment form: Once you have signed your life insurance contract and paid your first premiums, complete a collateral assignment form with your insurer. You will need to provide your lender's contact details so that your insurer can designate them as a collateral assignee while your loan is outstanding.
• Sign and submit the form: After completing the collateral assignment form, you and your lender must sign it. Your insurer may be able to provide electronic versions of the documents and e-signature capabilities to streamline the process. Wait for your bank to confirm that your insurer has made them the collateral assignee, then apply for your chosen loan.

It is important to note that using your life insurance policy as collateral may impact your beneficiaries if you default on the loan or pass away with an outstanding balance. Either event could reduce the death benefit payout that your beneficiaries receive.

In addition, if you are using a permanent form of life insurance as collateral, there may be an impact on your ability to use the policy's cash value during the life of the loan. If the loan balance and interest payments exceed the cash value, it can erode the policy's value over time.

Life insurance loans

The cash value of a permanent life insurance policy can be borrowed against to fund major expenses or necessities. This can be particularly useful if you need immediate funds and don't have time to wait for a traditional loan application to be processed, as there is no credit check or approval process required for a life insurance loan. The funds are also tax-free, although there are typically interest payments to be made.

Insurers have different rules about how much cash value a policy must have before it can be borrowed against, and what percentage of the cash value can be borrowed. It usually takes about 10 years for a policy to accumulate enough cash value to borrow against.

While repayment of a life insurance loan is often optional, if the loan is not repaid, the death benefit will be reduced. Additionally, if the interest accrued on the loan is not paid, it could eventually exceed the cash value of the policy, causing it to lapse. In this case, the cash value taken out may be treated as income by the IRS and taxed accordingly. Therefore, it is important to set a personal repayment schedule to ensure the loan is repaid without accruing significant interest.

Before taking out a life insurance loan, it is recommended to consult a financial advisor to weigh the pros and cons and understand the potential tax implications.

Withdrawing funds from your policy

Withdrawing funds from your life insurance policy is a straightforward process. A simple phone call to your insurance company is all it takes to get the cash you need. However, it's important to understand the potential consequences of this decision, as withdrawing funds will reduce the death benefit your beneficiaries will receive and may have tax implications.

Here's what you need to know about withdrawing funds from your life insurance policy:

Understanding Cash Value

Before you withdraw funds, it's important to understand how cash value works in a life insurance policy. Cash value is a feature of permanent life insurance policies, which includes whole life and universal life insurance. The cash value component allows your policy to accumulate cash over time, which can be accessed while you're still alive. This is in addition to the death benefit that will be paid out to your beneficiaries when you pass away.

Ways to Withdraw Funds

There are a few different ways to withdraw funds from your life insurance policy:

• Withdrawal: You can simply take money out of the cash value, usually up to the amount you've paid in premiums, without paying taxes on the funds. However, withdrawals will reduce your death benefit, and if you withdraw more than your basis (the amount you've paid into the cash value), you may owe income tax on the earnings.
• Loan: You can borrow money from your insurance company using your cash value as collateral. You don't have to qualify for the loan financially, and you can choose whether or not to repay it. If you don't repay it, the loan amount and interest will be deducted from the death benefit. Keep in mind that the interest rates on policy loans are typically lower than those on personal loans or home equity loans.
• Surrender: If you no longer need your life insurance policy, you can surrender it and receive the accumulated cash value, minus any surrender fees and taxes. However, surrendering your policy means giving up your life insurance coverage and the death benefit.

Things to Consider

When deciding whether to withdraw funds from your life insurance policy, there are a few important things to consider:

• Impact on Death Benefit: Withdrawing funds, especially in large amounts, will reduce the death benefit that your beneficiaries will receive when you pass away. This is something to carefully consider before making any withdrawals.
• Tax Implications: Withdrawing more than your basis (the amount you've paid into the cash value) may trigger income tax on the earnings. Additionally, if you surrender your policy, you may owe taxes on any gains earned on the cash value portion.
• Alternative Options: Before withdrawing funds from your life insurance policy, consider other options such as borrowing against your 401(k) plan, taking out a personal loan, or exploring other sources of income. Weigh the pros and cons of each option before making a decision.

In conclusion, withdrawing funds from your life insurance policy can be a convenient way to access cash, but it's important to understand the potential consequences and consider alternative options. Be sure to consult a financial advisor or tax professional to fully understand the implications of withdrawing funds from your life insurance policy.

Surrendering your policy for cash

Surrendering your life insurance policy means cancelling it and receiving a payout. This payout is called the surrender value, and it's the cash value of the policy minus any surrender fees. Surrendering your policy is a big decision, as your loved ones will no longer receive a death benefit.

The surrender value of a policy is based on the portion of premiums that went into the cash value account, plus the interest rate paid or investment gains. From that, outstanding loans and any surrender fees are subtracted.

Surrender fees tend to decrease over time, so it's best to wait until the fee is minimal or non-existent before surrendering your policy. Plus, the longer you've held the policy, the larger the cash value will be.

If the cash surrender value is worth more than you've paid in premiums, you will need to pay income taxes on the difference.

Before surrendering your policy, consider the various other ways to access your cash value, including withdrawing funds, borrowing against your policy, or selling your policy.

If you need cash but want to keep your policy, you can withdraw funds from the cash value portion of your policy. As long as you withdraw only up to the amount you've paid in premiums (known as the cost basis), you won't owe taxes. You can withdraw more than the cost basis, but you'll have to pay taxes on the excess. However, a withdrawal will reduce the death benefit that your beneficiaries receive.

You can also borrow against your policy's cash value. There is no loan application process or credit check involved, and you only need to pay interest, usually at a low rate. If you die before the loan is repaid, the outstanding balance is deducted from the death benefit paid to your beneficiaries.

Another option is to sell your policy to a third party in what's known as a life settlement. You'll receive a one-time cash payment, often for more than the surrender value. The buyer assumes responsibility for the policy, including making premium payments, and receives the death benefit when you die. Life settlements are generally intended for older people in declining health.

Frequently asked questions