Cashing In Your Life Insurance Policy

People are sometimes left scrambling for cash during difficult economic times to fulfill basic bills and lifestyle expectations. You may certainly cash in your life insurance policy to get funds when you need them, but should you?

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There are some disadvantages to utilizing life insurance to fulfill immediate cash demands, especially if you're jeopardizing your long-term ambitions or the financial future of your family. Life insurance, particularly cash-value life insurance, can be a source of required income if other options are not accessible.

TAKEAWAYS IMPORTANT

• If you don't have any other options and need to access your life insurance policy, withdrawing or borrowing money is preferable to surrendering the policy entirely.
• Excess premium payments and earnings are retained in a cash accumulation account under a cash-value life insurance policy, such as whole life or universal life.
• These accounts allow policyholders to access their money through withdrawals, policy loans, or relinquishing the account, in part or in full, if necessary.
• Another alternative is to sell your life insurance policy to a person or a firm that specializes in life settlements in exchange for cash.

How You Can Access Cash

Cash-value life insurance, such as whole life and universal life, accumulates reserves by combining excess premiums with earnings. These funds are retained in the policy's cash-accumulation account.

Cash-value Withdrawals, policy loans, and partial or complete surrender of the policy are all options for accessing cash accumulations within a life insurance policy. Another option is to sell your insurance for cash, which is referred to as a life settlement.

Keep in mind that, while cash from the policy may be valuable during difficult financial circumstances, depending on the way you take to access the funds, you may face unfavorable repercussions.

Withdrawals

A life insurance policy can usually be accessed for a limited amount of money. The amount you have depends on the type of insurance you have and the company that issued it. The fundamental benefit of cash-value withdrawals is that they are tax-free up to the amount of your policy, as long as your policy is not categorized as a modified endowment contract (MEC). A MEC is a word used to describe a life insurance policy with a financing amount that exceeds the federal tax law limits.

Cash withdrawals, on the other hand, can have unanticipated or unintended consequences:

• Withdrawals that lower your cash value may result in a reduction in your death benefit, which could be a valuable source of funds for your dependents for income replacement, business objectives, or wealth preservation.
• Withdrawals of cash value are not usually tax-free. Some or all of the withdrawn cash could be liable to taxation if you take a withdrawal during the first 15 years of the policy and the withdrawal reduces the policy's death benefit.
• To the extent that your withdrawals exceed your policy's basis, they are considered taxable.
• Withdrawals that lower your cash surrender value may cause your premiums to rise in order to keep the same death benefit; otherwise, the policy may lapse.
• If your insurance is categorized as a MEC, withdrawals are taxed similarly to annuities—cash disbursements are regarded to be made first from interest and are subject to income tax as well as a 10% early-withdrawal penalty if you're under the age of 5912 at the time of the withdrawal.

Loans

You can borrow money from the issuer using your cash-accumulation account as security in most cash-value policies. The loan may be subject to interest at varied rates, depending on the terms of the insurance; however, you are not need to be financially qualified for the loan. The amount you can borrow is determined by the cash-accumulation account value and the terms of the policy.

The good news is that non-MEC policy borrowings are not taxable, and you are not required to make loan payments, even if the outstanding loan sum may be accruing interest.

The bad news is that loan sums diminish the death benefit of your policy, which means your beneficiaries may receive less than you expected. In addition, an unpaid loan with interest diminishes your cash value, which can cause your policy to lapse if you don't pay enough premiums to keep the death benefit. If the loan is still due when the policy expires or you surrender the insurance later, the borrowed amount is taxable to the extent that the cash value (less the outstanding loan) exceeds the cash value.

Policy loans from a MEC policy are classified as distributions, which means that the amount of the loan up to the policy's earnings will be taxable and may be subject to the pre-5912 early-withdrawal penalty.

Giving Up a Policy

You can surrender (cancel) your policy and utilize the money in any way you like, in addition to withdrawals and policy loans. Surrender costs will almost certainly be paid by the firm if you surrender the policy during the first few years of ownership, decreasing your cash value. The amount you pay depends on how long you've held the policy. Furthermore, if you surrender your policy for cash, the gain on the policy is taxed, and if you have an outstanding loan balance against the policy, you may be subject to further taxes.

Although surrendering the policy can provide you with the cash you require, you are essentially giving up your entitlement to the insurance's death benefit protection. If you want to replace the lost death benefit later, it may be more difficult or expensive to do so.

Settlement of a Life

This is a straightforward concept. You sell your life insurance policy to an individual or a life settlement company in exchange for cash as the policy owner. When you die, the new owner will maintain the insurance in force (by paying the premiums) and profit from it by getting the death benefit.

Most types of insurance, even policies with little or no cash value, such as term insurance, are available for purchase. You (the insured) must be at least 65 years old, have a life expectancy of 10 to 15 years or less, and a policy death benefit of at least $100,000 to qualify for a life settlement (in most cases).

The main benefit of a life settlement is that you may be able to collect more money for your insurance than if you pay it in (surrendering the policy). Life settlements are taxed in a unique way: Gains in excess of your policy's basis are treated as ordinary income and are taxed accordingly. Before you hand over your policy, make sure you seek professional tax guidance.

Despite the fact that life settlements might be a beneficial source of cash, keep the following points in mind:

• You are relinquishing authority over the death benefit.
• The new policy owner(s) will have access to your medical information from the past and, in most cases, the ability to request updates on your current health.
• Because the life settlement sector is only loosely regulated, there is no guidance as to the value of your insurance, making it difficult to assess whether you're paying a fair price for it.
• Aside from the potential tax liability, life settlements frequently come with an additional cost: Commissions and fees could account for up to 30% of your earnings, lowering the net amount you receive.

Final Thoughts

You might consider liquidating assets for cash if you're in financial hardship. You may have no other option in some cases, but when it comes to life insurance, consider why you bought the policy in the first place. Is the insurance still required? Are the beneficiaries of your policy reliant on the death benefit if you die? Take time to think about the responses to these questions.