Unlocking Cash From Life Insurance Policies

Life insurance is typically taken out to provide a financial safety net for loved ones after the policyholder's death. However, life insurance can also be a source of cash while the policyholder is still alive. This is a benefit of permanent life insurance policies, which are typically more expensive than term life insurance policies. Permanent life insurance policies that have accumulated cash value can be used to pay premiums, take out loans, or withdraw cash. Withdrawing cash from a life insurance policy will usually reduce the death benefit and may have tax implications.

Cancelling your life insurance policy

Term Life Insurance Policy

If you no longer want your term life insurance policy, you can simply stop paying the premiums, and the policy will lapse. You may also be able to cancel the policy and receive a partial refund for any months you've paid in premiums upfront. However, if you decide to purchase life insurance again in the future, your rates will be higher as you will be older and possibly less healthy.

Whole Life/Permanent Life Insurance Policy

Cancelling a whole life or permanent life insurance policy is more complex due to the cash value component. Surrendering a permanent life insurance policy means you will receive the "surrender value", which is the cash value minus any surrender fees and outstanding policy loans. In the early years of the policy, surrender fees can significantly reduce or even eliminate the cash value you receive. Over time, these fees decrease, but it's important to understand that surrendering the policy prematurely may result in a lower cash value than expected.

Free Look Period

If you've recently purchased a life insurance policy, you're likely still within the "free look" period, which typically lasts 10 to 30 days, depending on your state. During this period, you can cancel your policy without any financial penalty and receive a full refund of any premiums paid. After this period, cancelling the policy may involve more steps and potential financial implications.

Steps to Cancel Your Policy

To cancel your life insurance policy, contact your insurance provider and inform them of your decision. You may need to fill out a cancellation form. If you have a whole life insurance policy, consider how long you've had the policy, the accumulated cash value, and any applicable surrender fees. If you have an older policy with considerable cash value, inform your insurer of your wish to surrender the policy, and they will guide you through the process, including any requirements and fees.

Alternatives to Cancellation

Before cancelling your life insurance policy, consider the following alternatives:

• Reduce your life insurance coverage: Contact your insurance provider to discuss temporarily reducing your coverage amount to lower your premiums.
• Withdraw or borrow from your cash value: If you have a whole life insurance policy and are in a cash crunch, you can withdraw from or borrow against the policy's cash value. Keep in mind that this will incur interest and reduce the death benefit for your beneficiaries.
• Request a new medical exam: If your premiums are high due to poor health when you purchased the policy, you can request a new medical exam to demonstrate improved health and qualify for a more competitive premium.
• Get a new life insurance policy: Shop around and compare quotes to find a new life insurance policy with more competitive rates.

Withdrawing from your life insurance policy

Understanding Your Policy

Before considering a withdrawal, it is crucial to understand the type of life insurance policy you have. Withdrawals are typically only possible with permanent life insurance policies, such as whole life or universal life insurance. These policies have a cash value component that grows over time as you pay your premiums. Term life insurance policies, on the other hand, do not have a cash value component and do not allow for withdrawals.

Partial Withdrawal

If you have a permanent life insurance policy, you may be able to make a partial withdrawal from the cash value. This option allows you to access the funds you need while maintaining some coverage. However, it is important to note that a partial withdrawal will likely result in a reduced death benefit for your beneficiaries. The specific terms of your policy will determine the extent of the reduction. Additionally, withdrawals up to the amount of premiums you have paid are generally not subject to income taxes.

Full Withdrawal or Surrender

You also have the option to surrender your policy and withdraw its entire cash value. This action will terminate your coverage, and your beneficiaries will no longer be entitled to a death benefit. Surrendering your policy may also incur surrender fees or charges, especially if you do so during the early years of the policy. Furthermore, if your payout exceeds the amount of premiums you have paid, you may owe income taxes on the gain.

Loans Against the Policy

Another option to access cash from your life insurance policy is to take out a loan against the policy's cash value. This can be done without a credit check and with flexible repayment terms. However, any amount you owe on the loan, including interest, will be deducted from the death benefit if it remains unpaid when you pass away. It is important to carefully consider the potential impact on your beneficiaries before taking out a loan against your life insurance policy.

Using Cash Value for Premium Payments

In some cases, you may be able to use the cash value of your life insurance policy to pay your premiums. This option can be helpful if you are facing financial difficulties and struggling to make out-of-pocket premium payments. However, it is important to monitor your cash value and ensure that it does not deplete to the point where your policy lapses.

Weighing the Pros and Cons

Seeking Professional Advice

Before making any decisions regarding your life insurance policy, it is always recommended to consult with a financial advisor or a licensed insurance agent. They can help you understand the specific terms and conditions of your policy, as well as explore alternative options that may be better suited to your financial needs and goals.

Borrowing from your life insurance policy

Firstly, you can only borrow against a permanent life insurance policy, meaning either a whole life insurance or universal life insurance policy. Term life insurance, which is cheaper and more suitable for many people, does not have a cash value. It is designed to last for a limited period, generally anywhere from one to 30 years. However, in some cases, a term life policy can be converted into a permanent policy, in which cash value can build up.

Secondly, policy loans reduce the death benefit if not paid off. Life insurance companies add interest to the loan balance, which, if unpaid, can cause the policy to lapse. Only permanent life insurance builds up cash value. Term policies do not.

Both whole life and universal life insurance policies are more expensive than term policies but have no predetermined expiration date. If sufficient premiums are paid, the policy is in force for the lifetime of the insured. While the monthly premiums are higher than term, the money paid into the policy that exceeds the cost of insurance builds up a cash value account that is part of the policy. The purpose of the cash value is to offset the rising cost of insurance as you age, so that premiums can remain level throughout life and not rise to unaffordable amounts in your later years.

Permanent life insurance has a few important values: the face value, the death benefit (often the same as the face value), and the cash value. One common misconception is that the cash value increases the death benefit. This is only true for certain types of permanent policies; on most policies, it does not increase the death benefit.

The money in the cash value grows at a rate that depends on the type of policy. For example, in a regular universal life policy, it grows based on current interest rates, while in a variable universal life policy, the cash value is invested by the owner in the stock market (and grows accordingly). It usually takes at least a few years for the cash value to build up to sufficient levels to take out a loan.

Unlike a bank loan or credit card, policy loans do not affect your credit, and there is no approval process or credit check since you are essentially borrowing from yourself. When borrowing on your policy, no explanation is required about how you plan to use the money, so it can be used for anything from bills to vacation expenses to a financial emergency.

The loan is also not recognised by the IRS as income, so it remains free from tax as long as the policy stays active (provided it's not a modified endowment contract). It's still expected that a policy loan will be paid back with interest (though interest rates are typically much lower than on a bank loan or credit card) and there is no mandatory monthly payment.

A policy loan reduces your available cash value and death benefit. If you pass away while owing money on a life insurance loan, it will reduce the amount your beneficiaries receive. Therefore, it is important to pay the loan back in a timely manner—on top of your regular premium payments. If unpaid, interest is added to the balance and accrues, putting your loan at risk of exceeding the policy's cash value and causing your policy to lapse. If that happens, it's likely you'll owe taxes on the amount you borrowed.

Insurance companies generally provide many opportunities to keep the loan current and prevent lapsing. If the loan is not paid back before the insured person's death, the loan amount, plus any interest owed, is subtracted from the amount the beneficiaries are set to receive from the death benefit.

Using cash value to pay premiums

Using the cash value of a life insurance policy to pay premiums is a useful option for those who want to keep their policy in place but need to reduce their monthly expenses. This is especially relevant for retirees who want to continue coverage but need to cut down on costs.

If you have a permanent life insurance policy, you can use the cash value to pay your premiums. This is because permanent life insurance policies, such as whole life and universal life, can accumulate cash value over time. A portion of each premium payment is allocated to the cost of insurance, while the remainder is deposited into a cash value account. This cash value grows over time as it earns interest, and taxes are deferred on the accumulated earnings.

Once your cash value reaches a certain point, you can use it to pay your premiums. However, it's important to note that any amount taken from the cash value account and not repaid before your death will reduce the death benefit paid to your beneficiary. Therefore, it is recommended to consult with a financial advisor to understand the potential consequences of accessing your cash value.

Additionally, it's worth mentioning that cash value life insurance policies are more expensive than term life insurance policies due to the cash value component. Before deciding to use the cash value to pay premiums, it is essential to weigh the pros and cons, considering the costs, tax implications, and the impact on your financial plan.

Selling your life insurance policy

How to sell your life insurance policy

The process of selling a life insurance policy begins with finding an interested buyer, meeting the basic qualifications, and then discussing your options with a licensed provider. Here are the steps:

• Find an experienced life settlement provider.
• Meet the qualifying factors, such as owning a policy with a death benefit of $100,000 or more and being over the age of 60.
• Take a detailed health questionnaire.
• Provide authorization to the provider to access medical records and contact the insurance company on your behalf.
• Share your policy details with the life settlement provider, including a copy of the policy contract and a premium illustration.
• Wait for the underwriting process to be completed.
• Complete the closing process, which involves the transfer of ownership of the policy and all accompanying documentation.

Pros and cons of selling your life insurance policy

Pros

• End premium payments: Life settlements relieve you from the obligation to pay expensive premiums.
• Get more cash than the surrender value: Life settlements provide, on average, four times more money than the accumulated cash surrender value.
• Access to large amounts of cash: For those nearing or in retirement, a life insurance policy could represent an unexpected source of cash to supplement retirement income or pay down bills.
• Recoup money you've paid in: If you were to lapse a term policy, you'd get nothing back from all the money you've paid in over the years. A life settlement can help you get some of your investment back.

Cons

• Potential tax liability: In most cases, you won't owe income taxes on life settlement proceeds unless the settlement is greater than the total amount you've paid into the policy over the years.
• Ask about fees or commissions: If you work with a broker instead of going directly to a life settlement provider, the broker will take a commission.
• You may lose eligibility for financial assistance: If you currently receive Medicaid or other types of financial assistance programs, check with a financial advisor to understand eligibility rules before accepting a life settlement offer.
• Eliminates death benefit: Your beneficiaries will no longer receive the death benefit associated with the policy.

Frequently asked questions