In tough economic times, people are sometimes left to make money to meet daily expenses and lifestyle demands. Your life insurance policy is a possible source of funding, but should you take advantage of it?
There are certainly drawbacks to using life insurance to cover immediate cash needs, especially if you are compromising your long-term goals or your family’s financial future. However, if no other options are available, life insurance, especially cash value life insurance, can be a necessary source of income.
Methods of accessing cash in life insurance
Money-valued life insurance, like all life and universal life, builds reserves through excess premiums and earnings. These deposits are held in a money storage account under the policy.
Money-value life insurance provides the opportunity to access the accumulation of liquidity within the policy through withdrawals, policy loans, or partial or full delivery of the policy. Another alternative is to sell the policy for cash, a method known as a life settlement.
Remember that although cash from the policy can be useful during times of financial stress, you may face unintended consequences depending on the method you use to access the funds. (For related reading, see: Can I Borrow Money From My Life Insurance Policy?)
Withdrawals
In general, it is possible to withdraw limited amounts of money from a life insurance policy. The amount available differs based on the type of policy you own and the company issuing it. The main benefit of cash value withdrawals is that they are not taxable until your policy, as long as your policy is not classified as a Modified Endowment Agreement (MEC).
However, withdrawals of cash value can have unexpected or unrealized consequences:
- Withdrawals that reduce cash value could cause a reduction in death, a potential source of funds that you or your family may need for income replacement, business purposes, or asset preservation.
- Withdrawals of monetary value are not always tax-free. For example, if during the first 15 years of the policy you make a withdrawal and the withdrawal causes a reduction in the benefit in the event of the policy’s death, some or all of the cash withdrawn may be subject to taxation.
- Withdrawals are considered taxable to the extent that they exceed your policy base.
- Withdrawals that reduce the cash surrender value could increase premiums to maintain the same death benefit; otherwise, the policy may expire.
- If your policy has been classified as MEC, withdrawals are generally taxed under the rules applicable to annuities – cash disbursements are considered to be made from interest and are subject to income tax and possibly a 10% penalty for early retirement if you are under 59 years old. 5 at the time of collection. (For related reading, see: Avoiding the Trap of the Modified Endowment Contract.)
Loans
Most cash-value policies allow you to borrow money from the issuer using your cash accumulation account as collateral. Depending on the terms of the policy, the loan may be subject to interest at variable rates; however, you are not required to financially qualify for the loan. The amount you can borrow is based on the policy’s accumulated cash account value and the terms of the contract.
The good news is that sums borrowed from non-MEC policies are non-taxable and you don’t need to make payments on the loan, even though the loan balance may be with interest.
The bad news is that loan balances generally reduce the policy’s death benefit, meaning beneficiaries may receive less than expected. Additionally, an unpaid loan that is accruing interest reduces the cash value, which can cause the policy to lapse if insufficient premiums are paid to maintain the death benefit. If the loan is still pending when the policy expires or if the insurance is subsequently disposed of, the borrowed amount becomes taxable to the extent that the cash value (without reduction for the outstanding loan balance) exceeds the base. of the contract.
Policy loans from a policy deemed to be MEC are treated as distributions, which means that the loan amount up to the earnings in the policy will be taxable and may even be subject to 59. 5 early withdrawal penalties. (For more information, see: Information on Life Insurance Loans.)
Deliver a policy
In addition to policy withdrawals and loans, you can waive (cancel) the policy and use the money in any way you see fit. However, if you opt-out of the policy during the first few years of ownership, the redemption costs will likely be charged by the company, reducing the cash value. These charges vary depending on how long you’ve had the policy. In addition, when you opt-out of the policy for cash, the gain on the policy is subject to income tax, and if you have an outstanding loan balance with respect to the policy, additional taxes may be charged. Although divesting the policy may get you the money you need, you are obviously giving up the right to death protection offered by the insurance.
Life Settlement
This concept is quite simple. As the owner of the policy, you sell your life insurance policy to one person or one
life settlement company in exchange for money. The new owner will keep the policy in effect (paying the premiums) and reap a return on your investment by receiving the death benefit when you die. (For more information, see: Unwanted Life Insurance Profit with Life Settlement.) Most types of insurance are eligible for sale, including policies with little or no cash value, such as
insurance. Generally, to obtain a life agreement, the policyholder must be at least 65 years old, have a life expectancy of 10 to 15 years or less, and a political death benefit of at least $ 100,000 (in most cases). The main benefit of a lifetime deal is that you can potentially get more for the policy rather than cash it (by surrendering the policy). Life Settlement Taxation Is Complicated: The general treatment is that the income above your base in the policy is taxed as ordinary income
. Make sure you get tax advice before signing your policy. Although life settlements can be a valuable source of liquidity, consider the following issues: You are giving up control of the death benefit. New policy owners will have access to past medical records and generally the right to request current health updates.
- The life settlements industry is very marginally regulated, so there is no indication as to the value of your policy, making it difficult to determine if you are getting a fair price for your policy.
- Aside from the tax debt you may face, life settlements usually come at another cost: up to 30% of your proceeds could be paid in
- commissions
- and commissions, which reduces the net amount you receive. The Bottom Line Economic troubles can lead you to contemplate liquidating your assets in cash. Sometimes you may have no other choice, but when it comes to life insurance, think about why you bought the policy in the first place. Do you still need coverage? Are the beneficiaries of the policy dependent on the death benefit if something happens to you?
You should also consider other alternatives before using the cash life insurance policy. Some options might include loans against the 401 (k) plan or taking out an equity loan
. Beyond the lottery, none of these options come without extenuating issues, but based on current needs and financial circumstances, some choices may be better than others. (For related reading, see: How the value of cash develops in a life insurance policy
