Unlocking Life Insurance: Withdrawing Money From Your Policy

Life insurance is typically taken out to provide financial protection for loved ones after the policyholder's death. However, some types of life insurance policies also have a cash value component that can be withdrawn while the policyholder is still alive. This type of policy is called permanent life insurance, and it differs from term life insurance, which does not have a cash value component. Permanent life insurance includes whole life insurance, universal life insurance, and indexed universal life insurance. Withdrawing cash from a permanent life insurance policy is relatively simple, and there are four main ways to do so: withdrawing, borrowing, surrendering, and selling. However, it's important to consider the pros and cons of each option before making a decision, as withdrawing cash can reduce the death benefit and may have tax implications.

Surrendering the policy

Surrendering your life insurance policy means telling your insurance company that you no longer want life insurance coverage. In exchange, you will receive 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 due to surrender charges.

Surrendering a policy can be a valuable source of quick cash for those without access to other liquid assets. However, it is important to consider the downsides of this option. Firstly, you will be giving up your right to the death benefit afforded by the insurance, which may cause complications if you wish to replace the lost death benefit later. Secondly, if you surrender the policy during the early years of ownership, when the value is relatively low, the company will likely charge surrender fees, further reducing your cash value. These charges vary depending on how long you've had the policy and the amount being surrendered. Some policies can levy surrender charges for many years after the policy is issued. Finally, when you surrender your policy for cash, the gain on the policy may be subject to income tax. Additional taxes could be incurred if you have an outstanding loan balance against the policy.

Before surrendering your policy, it is important to consider your options and decide if it is the best choice for you. There are several alternatives to a cash value surrender that can pay more, such as direct withdrawals, taking out a loan using the policy as collateral, or a life settlement.

Borrowing against the policy

Borrowing against your life insurance policy can be a quick and easy way to get cash in hand when you need it. However, there are a few key things to know before borrowing.

Firstly, it's important to understand that you can only borrow against a permanent life insurance policy, such as a whole life insurance or universal life insurance policy. These policies are more expensive than term life insurance but have no predetermined expiration date. If sufficient premiums are paid, the policy remains in force for the lifetime of the insured. While the monthly premiums are higher than term life insurance, money paid into the policy that exceeds the cost of insurance builds up a cash value that is part of the policy. This cash value is what you can borrow against.

The cash value of a permanent life insurance policy grows over time as you pay your premiums. If your balance is large enough, you can borrow money from your insurer, using your policy as collateral. There is usually no approval process or credit check, and you can use the money for anything you want. The interest rates on these loans are typically much lower than on a bank loan or credit card, and the loan is not recognised by the IRS as income, so it remains tax-free as long as the policy stays active.

However, borrowing against your life insurance policy is not without risk. If you don't make regular payments, your policy will be in jeopardy of lapsing, especially if the amount you owe exceeds the policy's cash value. In this case, you may owe taxes on the amount you borrowed. Additionally, if you pass away with an outstanding loan on your policy, the loan amount and any interest owed will be deducted from the death benefit, reducing the amount your beneficiaries receive.

Before taking out a loan against your life insurance policy, it's important to weigh the pros and cons and consult a financial advisor to understand the potential tax implications.

Withdrawing from the cash value

Understanding Cash Value Life Insurance

Cash value life insurance policies, such as whole life or universal life insurance, offer both a death benefit and a cash value component. This means that, in addition to providing a payout to your beneficiaries upon your death, these policies also accumulate cash value over time. This cash value can be accessed during your lifetime through withdrawals or loans, providing a source of funds for various expenses. However, it's important to weigh the pros and cons before making any withdrawals.

Withdrawing money from the cash value of a life insurance policy is relatively straightforward. Here are the common methods:

• Surrendering the Policy: This involves cancelling the policy and receiving the accumulated cash value, usually after paying a surrender fee. This option terminates the policy, leaving your beneficiaries without a death benefit.
• Taking Out a Loan: Some policies allow you to borrow money from the insurer, using your policy's cash value as collateral. The loan must be repaid with interest, or the amount owed will be deducted from the death benefit upon your death.
• Making Partial Withdrawals: Depending on the policy, you may be able to withdraw a portion of the accumulated cash value without surrendering the entire policy. This option reduces the death benefit that your beneficiaries will receive.

Using the Withdrawn Funds

The funds withdrawn from the cash value of your life insurance policy can be used for various purposes:

• Withdrawals: You can use the money for any financial need or planned expense, such as a down payment on a house.
• Loans: Taking out a loan against your cash value can help cover expenses such as a car purchase, retirement income, or temporary financial difficulties.
• Premium Payments: If you have accumulated enough cash value, you may be able to use it to pay your insurance premiums, freeing up cash flow for other expenses.

Considerations and Potential Consequences

When considering withdrawing from the cash value of your life insurance policy, it's important to keep the following in mind:

• Tax Implications: Withdrawals up to the amount of premiums paid are generally not taxable. However, withdrawals exceeding this amount may be subject to income taxes.
• Reduced Death Benefit: Withdrawals and loans will reduce the death benefit that your beneficiaries will receive upon your death.
• Interest Charges: Borrowing against your policy may incur interest charges, further reducing the death benefit if left unpaid.
• Surrender Fees: Cancelling your policy and withdrawing the cash value may incur surrender fees, especially if the policy is relatively new.
• Policy Lapse: Withdrawing too much from your policy may cause it to lapse or terminate, leaving you without coverage.

In conclusion, withdrawing from the cash value of a life insurance policy can provide much-needed funds during your lifetime. However, it's important to carefully consider the potential consequences, such as reduced death benefits, tax implications, and the impact on policy coverage. It's always a good idea to consult a financial professional before making any decisions regarding your life insurance policy.

Using the cash value to pay premiums

Using the cash value of your life insurance policy to pay premiums can be a good option if you're struggling to make payments. This can help you keep your policy in force while you weather a financial storm. However, it's important to note that this will impact the performance of your policy in the long term.

• Check with your insurance agent to understand the rules that apply. Not all policies allow for this option, and there may be specific requirements or restrictions.
• Request an "in-force illustration" from your life insurance company. This will outline how using the cash value to pay premiums will affect your policy's financial performance over time.
• Keep in mind that any type of withdrawal or policy loan can have a long-term impact on the performance of your policy. The cash value of your policy may take years to build up, and using it to pay premiums will reduce the overall amount.
• Weigh the pros and cons of this option against other alternatives, such as taking out a loan or making a withdrawal. Consider the potential impact on your death benefit, tax implications, and the overall growth of your policy.
• Consult a financial advisor to fully understand the consequences of accessing your cash value in this way. They can provide guidance on how it fits into your larger financial plan.

Selling the policy

Selling your life insurance policy can be a good way to unlock its financial value. There are two main ways to do this: a life settlement and a viatical settlement. Both allow you to sell your policy, but they are designed for different situations and offer varying payout amounts depending on your policy type and health condition.

Life settlement

A life settlement is typically for policyholders aged 65 or older who are experiencing a health decline. It is best suited for permanent policies that accumulate value over time and are in higher demand. Term policies can sometimes be sold, especially if they are convertible to permanent coverage or if the insured is terminally ill. However, offers may be lower.

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, so they offer a price that's profitable for them but higher than what you'd get by surrendering the policy.

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, ensuring that terminally ill individuals receive a fair percentage of the policy's value.

Tips for selling your life insurance policy

• Consider hiring an independent advisor to provide an accurate appraisal of your policy's value and help you understand the potential tax consequences.
• Find a reputable, licensed broker who can help you get the best possible offer by finding the highest bidder.
• Get multiple offers to make sure you're getting a fair deal.
• Round up your paperwork, including your medical history, as this will be required by potential buyers.

Tax considerations when selling your life insurance

Selling your life insurance policy may have tax implications, depending on the type of settlement you choose.

• Viatical settlement: If you're terminally ill, the money is generally tax-free.
• Life settlement: Any amount above what you've paid in premiums is taxed as ordinary income, and amounts above the cash value of the policy are considered capital gains.

Pros and cons of selling your life insurance policy

Pros

• Immediate cash flow: Selling your policy can provide you with a lump-sum payment.
• Relief from premium payments: Selling your policy can free you from the financial obligation of ongoing premium payments.
• More value than surrendering: A settlement usually offers a higher payout than simply surrendering your policy.

Cons

• Loss of death benefit: Once you sell your policy, your beneficiaries will no longer receive a death benefit.
• Possible tax implications: Proceeds from a life settlement could be taxed as ordinary income.
• Medicaid eligibility impact: Selling your policy could affect your eligibility for Medicaid and other needs-based programs.
• Health check-ins: The buyer of your policy may have the right to inquire about your health and life expectancy.
• Potential for multiple sales: The settlement provider that buys your policy may resell it, meaning your medical information may be disclosed to multiple third parties.

Frequently asked questions