Cashing In On Life Insurance: Prudential's 1938 Policy Explained

Life insurance is a crucial financial tool that helps protect your loved ones after your death. It provides them with a sum of money, known as a death benefit, to cover expenses and maintain their financial security. While term life insurance offers coverage for a specific period, permanent life insurance lasts indefinitely, often building cash value over time. This cash value can be accessed through loans or withdrawals, providing additional financial flexibility during your lifetime. However, it's important to carefully consider the benefits and drawbacks of each type of insurance policy and seek guidance from financial professionals to make informed decisions.

Permanent life insurance policies can build cash value over time

Permanent life insurance policies, such as whole life and universal life, can build cash value over time. This cash value is a savings component that accumulates on top of the death benefit. The cash value of a permanent life insurance policy can be used for several purposes, including borrowing against it, withdrawing it, or using it to pay policy premiums.

The cash value of a life insurance policy is built up through premium payments. These payments are split into three categories: a portion goes towards the death benefit, another towards the insurer's costs and profits, and the third contributes to the policy's cash value. Over time, as the policyholder ages, the amount of money allotted to cash decreases, while the amount paid to insurance increases. This is because the cost of insuring a life gets more expensive as the policyholder gets older.

There are different types of permanent life insurance policies that accumulate cash value in different ways. Whole life policies, for example, provide "guaranteed" fixed cash value accounts that grow according to a formula determined by the insurance company. Universal life policies, on the other hand, accumulate cash value based on current interest rates and investments. Variable life policies invest funds in sub-accounts that operate like mutual funds, with the cash value growing or falling based on the performance of these sub-accounts.

The cash value of a permanent life insurance policy can be accessed in several ways. Partial withdrawals are usually permitted, although these may reduce the death benefit. Some policies also allow for unlimited withdrawals, while others restrict the number of withdrawals that can be made during a specific period. Policy loans are also an option, with the outstanding loan amount reducing the death benefit in the event of the policyholder's death before the loan is fully repaid. Additionally, the cash value can be used to pay policy premiums, with the policyholder stopping out-of-pocket payments and instead using the accumulated cash value to cover the cost.

It is important to note that permanent life insurance policies with a cash value component tend to be more expensive than term life insurance policies. This is because a portion of each premium payment goes towards the cash value element. However, the cash value can help offset the cost of the policy over time.

Cash value can be used to pay premiums, borrow money or cash out

Permanent life insurance policies differ from term life insurance policies in that they offer the potential to build cash value. This cash value can be used in several ways:

Paying Premiums

Once your permanent life insurance account builds up enough value, you can withdraw funds to pay your premiums. However, it's important to keep an eye on the balance, as allowing it to drop too low can cause your coverage to lapse. Variable and universal life policies typically offer this option.

Borrowing Money

In the case of a financial emergency, significant medical expenses, or a large purchase, you can take out a loan against your accumulated cash value. This comes with several benefits: you won't have to go through a credit check, the loan can remain outstanding for as long as you want, and it won't show up on your credit reports. However, if you die with an unpaid balance on the loan, that amount will be deducted from your beneficiary's payout. Additionally, unless you make interest payments, interest will be added to the outstanding balance. And if the loan balance ever exceeds your policy's cash value, your coverage will be canceled, and you may owe income taxes on the loan.

Cashing Out

You can also choose to surrender your policy and take the cash. However, it's important to keep in mind that fees and surrender charges will be deducted, resulting in an amount that is less than the actual cash value. If you don't want to give up your policy entirely, you can make a partial withdrawal, although this will lower the death benefit.

Other Benefits of Permanent Life Insurance

Permanent life insurance policies offer several other advantages over term life insurance policies. Firstly, they last for your entire lifetime as long as you keep making payments, whereas term policies are temporary and last for a set period. Additionally, permanent policies can be used as a type of savings or investment vehicle, allowing you to accumulate value over time, tax-deferred, and draw on those funds while you're still alive. This accumulated cash value can also be used to provide extra retirement income or to pay less in taxes, as loans from the cash value of a permanent policy are typically income tax-free.

Cash surrender value is the amount left over after fees when you cancel a permanent life insurance policy

Cash surrender value is the amount of money a life insurance policyholder receives for cancelling their permanent life insurance policy before it matures or they pass away. This is the savings component of most permanent life insurance policies, such as whole life and universal life. It is also known as the policyholder's equity.

The cash surrender value is the amount of cash you've built up minus any surrender charges or fees. These charges diminish over time, so the longer you've had your account, the closer the cash surrender value will be to the cash value.

When you surrender a policy, you receive whatever you paid in premiums back tax-free. If you receive more than you paid in total premiums, you owe income tax on your earnings.

How to Calculate Cash Surrender Value

To calculate your cash surrender value, you must consider any fees your company will charge for cancelling your policy. Check your cash value balance, then subtract any surrender charges to determine how much money you will receive in a cash surrender.

For example, suppose you take out a variable universal life insurance policy for $100,000. You make five years of payments and build up a cash value of $10,000. However, the surrender charge will cost you 10% of the cash value. You will have to pay $1,000 in charges and will only get $9,000 out of the cash surrender.

Surrender Charges

In the early years of a policy, life insurance companies can deduct fees upon cash surrender. What you receive for your cash surrender value could be less than your current cash value balance after subtracting these fees.

The surrender charge can start as high as 10% to 35% of your policy cash value. If your policy has a surrender charge, it goes down over time. Most policies end the surrender charge after 10 to 15 years. At this point, your cash surrender value equals your cash value.

Alternatives to Surrendering Your Policy

Surrendering your policy is not always the best option. You can access policy cash in other ways, for example, with a policy loan.

If you have a permanent policy, talk to your life insurance provider to determine the best options for accessing policy cash value.

Prudential offers a few types of lump sum payment options

Proceeds Held at Interest

While proceeds are held at interest, you receive regular interest payments with the right to withdraw the unpaid balance. You may also elect to have interest accumulate.

Lump Sum Check

Receive the full benefit in a single lump sum check.

Prudential also offers a number of deferred payment options, which pay out the proceeds over a period of time that you select. For example, you could choose to receive monthly payments for the rest of your life, or payments over a fixed number of years. If you select a deferred payment option, Prudential will provide a written description of the terms of the installment payment option you chose.

Life Income

Monthly payments for life.

Life Income with a Certain Period

Monthly payments for life with a certain period of guaranteed payments to you or your named beneficiary.

Fixed Period

Payment for an elected number of years, with the right to withdraw the present value of unmade payments.

Fixed Amount

Payments of a selected amount until the proceeds and interest earned are fully paid to you, with the right to withdraw the unpaid balance.

The tax treatment of the death benefit may be different depending on the settlement option you choose. Please consult your tax advisor for advice. In addition, there may be other settlement options available to you.

Permanent life insurance can help with business continuation when a partner or key employee dies

Permanent life insurance is a valuable tool for business owners and partners to ensure the continuation of their business in the event of their death. It is also known as whole, universal, or variable life insurance, and it offers a death benefit for the beneficiary while also including a cash value element. This means that if a business owner or partner passes away, the beneficiary of the policy receives a payout, which can be used to ensure the business remains financially stable.

The death of a business owner or partner can create a management vacuum, leaving the business vulnerable. Without the deceased owner's contributions and leadership, the business may struggle financially and operationally. Permanent life insurance provides a financial safety net for the business, allowing the remaining partners to buy out the share of the deceased owner. This ensures that the business can continue operating without the risk of financial strain or ownership disputes.

Additionally, permanent life insurance can also be used to cover the loss of a key employee who does not have an ownership stake but whose contributions are critical to the company. For example, a software company may wish to insure against the loss of a senior programmer, as their absence could significantly disrupt the business. In such cases, life insurance can provide funds to minimise disruption and facilitate a smooth transition.

There are two common types of business continuation insurance: entity-purchase and cross-purchase policies. Entity-purchase policies name the business itself as the beneficiary, while cross-purchase policies cover specific individual business owners and partners, who receive benefits directly. Combined with buy-sell agreements, these insurance policies provide a clear and orderly succession strategy, ensuring that the business can continue even in the face of unexpected losses.

By planning ahead with permanent life insurance, business owners and partners can protect their business, mitigate financial risks, and ensure a smooth transition in the event of a partner's or key employee's death.

Frequently asked questions