Alyssa Lane
Permanent life insurance policies often contain a cash value component that policyholders can access during their lifetime. This cash value can be used to pay premiums, take out a loan, or withdraw cash permanently. However, accessing the cash value will reduce the available cash surrender value and may also reduce the death benefit. Policyholders can also choose to transfer the cash value to a new policy or annuity through a 1035 exchange, which is a tax-free rollover. It is important to carefully consider the options and seek expert advice to make an informed decision about what to do with the life insurance cash value.
Characteristics and Values of Life Insurance Cash Value Rollover
| Characteristics | Values |
|---|---|
| Cash value rollover | A 1035 tax-free exchange |
| Rollover type | Non-qualified annuity or transfer of a life insurance policy |
| Transfer type | Permanent life insurance policies |
| Transfer options | Universal, variable, whole life |
| Transfer destination | New life insurance policy or annuity account |
| Cash value usage | Paying premiums, loans, withdrawals, investments, expenses |
| Considerations | Tax implications, death benefits, account growth, fees |
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What You'll Learn
Weigh the pros and cons of cashing out
When you cash out your life insurance policy, you get the cash value of the policy, minus any fees or penalties. This can be a good source of funds if you need money for a major expense, such as a
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Consider a 1035 exchange
If you are dissatisfied with your life insurance policy, you can consider a 1035 exchange, which is a provision in the Internal Revenue Service (IRS) code that allows for a tax-free transfer of an existing annuity contract, life insurance policy, long-term care product, or endowment for another of like kind. This is a good option if you want to establish a new single-premium life insurance policy.
A 1035 exchange allows you to transfer your life insurance policy to an annuity account. This is a less common strategy but can be valuable in some cases. You can also transfer the cash value in your old life insurance policy to a new one. You are allowed to transfer all or some of the cash value in your variable, universal, or whole life insurance policy and deposit the funds on a tax-free basis into a new life insurance policy. However, you cannot transfer the funds into a term life insurance policy as these policies have no cash value for the insured.
It is important to note that you cannot avoid income taxes by purchasing a term policy with the cash value from an existing whole, variable, universal, or indexed life contract. You also cannot transfer any gains from an annuity account to a life insurance policy without first paying taxes on the deferred gains in the non-qualified annuity.
If you are considering a 1035 exchange, it is important to work with a knowledgeable agent to ensure you comply with all 1035 rules and regulations. Failing to do so may create taxable gains that cannot be undone.
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Use it to pay premiums
If you have built up cash value within your life insurance policy, you can use this money to pay future premiums. This is known as a 'premium payout' and can be a useful strategy for those who want to keep their life insurance policy but are finding it challenging to meet the regular premium payments.
Using the cash value to pay premiums can be a sensible option, especially if you are experiencing a financial strain or are entering retirement and will be living off a fixed income. It allows you to maintain the policy and, therefore, the death benefit, which can provide peace of mind and financial security for your loved ones.
However, it is important to note
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Take out a loan
If you have a permanent life insurance policy, you can borrow money from its cash value through a policy loan. This option is ideal if you need occasional cash, and you won't have to undergo a credit check. Interest rates typically range from 4% to 8%, depending on market rates and the type of policy you have.
When you take out a loan, you are not directly withdrawing money from your account. Instead, the insurance company lends you money while holding your policy as collateral. You can choose to pay the loan back with interest, or the amount can be deducted from the death benefit your beneficiaries receive if you pass away before paying it back. It's important to note that if you don't repay the loan, and the interest accumulates to a point where your loaned amount exceeds the cash value in your policy, your policy could lapse. This would leave you without coverage and could trigger tax implications.
The maximum loan amount you can take out will vary by insurance provider and is typically based on a percentage of your cash value. For example, you may be able to borrow up to 90% of your cash value. Additionally, there is usually no specific repayment schedule, so you can pay back the loan on your own timeline.
Before taking out a loan, carefully consider the potential impact on your death benefit and account value. Withdrawals from your account value may be subject to charges and interest, and they may generate an income tax liability. Therefore, it's important to consult a tax advisor to understand the potential tax implications of taking out a loan against your life insurance policy.
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Withdraw only what you need
If you have a permanent life insurance policy, it may have accumulated a significant amount of funds in its cash value. While you are alive, you can use this money to pay premiums, take out a loan, or withdraw cash permanently. However, it is important to carefully consider your options, as the way you access your cash value will impact the amount available to you, your death benefit, and your account’s growth.
One option is to withdraw only what you need. This is a more tax-effective option than cashing out your policy all at once. Withdrawals draw down the tax-free premium payments first; taxes are owed only after you start withdrawing the gains. It is recommended to keep some money for an emergency fund, perhaps 12 months' worth of expenses, with the rest used to supplement your retirement income.
You can also tap into the cash value through a policy loan. This way, you won't owe taxes for withdrawing gains, and you'll have the option to repay the money, whereas you can't reverse withdrawals. However, the insurer will charge interest for the loan, typically at a rate of 4% to 8% per year.
If you withdraw too much too early, the policy’s cash value could run out, forcing you to start paying more in premiums or risk having the coverage lapse. Withdrawing cash will also reduce the available cash surrender value and possibly the life insurance benefit. Therefore, it is important to ask the insurer how much you can safely withdraw per year based on the cash value balance and policy terms.
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Frequently asked questions
A 1035 exchange is an IRS tax code that allows for the tax-free rollover of a non-qualified annuity or the transfer of a life insurance policy to a new annuity or life policy of equal or greater value.
Any cash value growth above what you paid in premiums is taxed as ordinary income when withdrawn. Withdrawing only what you need each year can be a more tax-effective option.
You can borrow against the cash value to cover significant expenses, like a down payment on a home, or use it to pay premiums, take out a loan, or withdraw cash permanently.
