Life insurance policies are often viewed as a safety net for loved ones, but circumstances change. Whether you’re seeking extra cash for retirement, covering medical expenses or simply reducing financial burdens, there are several ways to tap into the value of your life insurance policy.
Here, we’ll compare the most common life insurance cash-out options, including surrendering your policy, keeping it, borrowing against it, converting to a paid-up policy or opting for a life settlement. By understanding the financial, tax and long-term implications of each choice, you can make an informed decision about how to get money from a life insurance policy.
SURRENDERING THE POLICY
Surrendering a life insurance policy is one of the most common ways people try to tap into the value of life insurance. When you surrender your life insurance policy, you cancel the policy completely. In return, your life insurance company gives you the cash surrender value of the policy. Generally, the surrender value is the policy’s accumulated cash value minus any surrender fees.
Financial Payout:
The surrender value of a policy is typically lower than other options for getting rid of or selling a policy. Most insurance companies base the surrender value on how much cash value you’ve accumulated over the years.
Despite a lower payout in most cases, the benefit of taking the surrender value of a policy is an immediate lump-sum payment. This could be an important factor if you’re canceling your policy due to urgent financial needs.
Tax Implications:
In general, you won’t have to pay taxes on the surrender value of your policy – up to the amount you’ve paid in premiums. If your surrender value is more than you paid in premiums over the years, you could be liable for taxes on the funds. Be sure to talk with a tax expert to learn more about your potential tax liabilities if you want to surrender a policy.
Long-Term Impact:
Surrendering a policy is essentially canceling it, so once you do so, the policy is no longer in force. This means your loved ones won’t receive a payout if you pass away, and the policy can’t grow in cash value.
Eligibility and Requirements:
To be eligible for a surrender value payout, a policy typically needs to be permanent life insurance with cash value. You may be able to surrender the policy at any time during its life.
However, surrendering a policy typically involves a surrender fee, which comes out of the final payout. Additionally, these fees tend to be higher for newer policies that are only a few years old.
KEEPING THE POLICY
If the death benefit remains a priority for your beneficiaries, you may choose to keep the policy and continue paying premiums. Keeping your policy means not actively tapping into your policy’s value. This allows your heirs to receive the full death benefit payout after your passing.
Financial Payout:
After you pass, your listed beneficiaries receive the full death benefit on your policy, excluding any outstanding loan balances or other fees.
Tax Implications:
Death benefit payouts tend to be tax-free for beneficiaries, which could be an important factor to consider when deciding whether to keep a policy.
Long-Term Impact:
The biggest long-term impact of keeping your life insurance policy is providing financial security for your beneficiaries. This could help you preserve your legacy and provide for your family, friends or other loved ones long after you’re gone.
However, if you keep the policy, you’ll need to keep paying insurance premiums to ensure coverage. Depending on your policy, health and financial situation, this could put a strain on your finances as you age.
Eligibility and Requirements:
If you already have a policy in force, you typically won’t need to meet eligibility requirements to keep it going, outside of paying your premiums.
BORROWING AGAINST A LIFE INSURANCE POLICY
A policy loan allows you to borrow from the cash value of your life insurance while keeping the coverage in force. You might think of this option as a cross between surrendering the policy and keeping it active. Taking out a loan against your policy lets you tap into the cash value without giving up the future financial benefits for your heirs.
Financial Payout:
The financial payout of a life insurance policy loan depends almost entirely on the cash value in the policy. Your insurance company will determine the exact amount you can borrow against your current cash value.
Tax Implications:
A policy loan is typically not taxed as long as the policy remains active.
Long-Term Impact:
Like most other types of loans, a policy loan includes interest charges on your balance. This could add up over time, depending on your loan amount and terms. Additionally, a loan with a remaining balance at the time of your death will reduce the death benefit payout.
Eligibility and Requirements:
Policy loans are only available for permanent policies with sufficient cash value for a loan. The amount of cash value needed for a loan can vary among insurance providers.
CONVERTING TO A PAID-UP POLICY
Some life insurance policies allow you to convert to a paid-up policy, which keeps your death benefit in place without requiring any further premium payments. You’ll either use cash value to cover future premiums or overpay your premiums to reach the required premium amount.
Another option is a reduced benefit paid-up policy. In a reduced-benefit policy, the insurance company lowers the death benefit of the policy in exchange for stopping any additional premium payments.
Once a policy reaches paid-up status, you can stop making premium payments and still enjoy insurance coverage for the remainder of your life.
Financial Payout:
Paid-up policies don’t provide immediate cash payments, but they do reduce immediate financial burdens by removing premium payments. In addition, your beneficiaries still receive a payout when you pass, though this may be reduced if you use the reduced paid-up method.
Tax Implications:
There are generally no taxes on converting a policy to paid-up status, and your beneficiaries will typically receive the death benefit tax-free.
Long-Term Impact:
Converting to a paid-up policy could help reduce your ongoing expenses while still maintaining life insurance coverage.
Eligibility and Requirements:
The terms to pay up a policy vary between carriers and policies, so it’s important to talk with your insurance company to see if your policy qualifies. Generally, you’ll need a permanent life insurance policy with sufficient cash value to cover premiums.
LIFE SETTLEMENTS
A life settlement involves selling a life insurance policy for a cash payout to a third-party buyer. The buyer becomes the new owner of the policy and pays the premiums. When the insured passes away, the buyer receives the death benefit.
Financial Payout:
When looking at a life settlement payout vs. cash surrender value, the settlement payout is generally much higher, as much as four to eight times the cash surrender value. Most life settlement buyers pay for a policy in a lump sum, which you can use as you see fit.
Tax Implications:
One way life insurance settlement vs. surrender is similar is in how the payout is taxed. Like surrendering your policy, the payout you receive for a life settlement is not taxed up to the amount you’ve paid in premiums. If your payout is higher than what you’ve paid in premiums over the life of the policy, you will likely owe taxes on the remaining amount.
However, a life settlement is often one of the best choices to get rid of a life insurance policy and get value out of it, even if you have tax liabilities. Thanks to a higher payout, you will likely still end up with more cash in your pocket than with other methods.
Long-Term Impact:
Selling your life insurance means you no longer have to pay premiums on the policy, as the buyer will take over that responsibility. However, your life settlement buyer also becomes the beneficiary and will receive the death benefit when you pass. This could eliminate any benefits for your heirs.
The good news is that many life settlement buyers will negotiate an agreement that lets you retain some of your death benefit, while you still get to stop paying premiums. Consider working with a professional life settlement broker to get the best deal on the settlement market.
Eligibility and Requirements:
The ideal client is a male or female in their mid-70s or older who has had a change in health since the policy was issued. An exception to this guideline would be a male or female in their 60s to early 70s who has multiple chronic medical conditions and a significant health change since the policy was issued. For an insured to qualify, their life expectancy is usually 15 years or less.
HOW MUCH CAN I GET FOR SELLING MY LIFE INSURANCE POLICY?
Choosing the right path for your life insurance policy depends on your financial goals, health and legacy priorities. While surrendering or borrowing against your life insurance policy may provide quick access to cash, a life settlement often offers a higher payout.
If your policy is no longer serving its original purpose, consider exploring a life settlement to maximize its value. Contact Life Settlement Advisors to learn more about your options and determine the best solution for your financial future.
