Tapping the cash value in a life insurance policy can give you a quick source of money during a financial emergency or other time of need. To do this, however, the life insurance policy must be a permanent, cash-value life insurance policy, and you must have had it in effect long enough to accrue a cash value, a minimum of about 10 years.
How much cash you can expect to tap from life insurance depends not only on how long the policy has been in place but also on whether the policy is a whole, universal or variable universal life insurance policy. Whole life policies have a minimum cash value guarantee that will increase if you choose to reinvest dividends rather than using them to reduce monthly premium payments or receive them as a cash disbursement. Universal life policies come with flexible premium payments, and paying more than the minimum increases the guaranteed cash value. Although variable universal life insurance policies also have flexible monthly premiums, the cash value in the policy gets invested in the open market, and because of this, there is no cash value guarantee,
The most common way to tap the cash in life insurance is to use the cash value of the policy as collateral, and, depending on insurance company regulations, borrow an amount up to the policy’s surrender value. Advantages to tapping the cash in life insurance via borrowing is that interest rates on the loan are most often lower than a credit card or bank loan, repayment is optional and loan proceeds are generally not taxable. On the down side, borrowing most often decreases the death benefit, and if you choose not to make payments and the amount borrowed plus the interest ever exceeds surrender value, the policy will most likely terminate.
A second option for tapping the cash in life insurance is to sell the policy to a third party. The process – called a viatical, life or senior settlement – is way to tap into more than the current surrender value of the policy but less than the net death benefit. The Financial Industry Regulatory Authority says that viatical settlements may be a good choice for an insured who no longer requires life insurance, is looking to surrender a life insurance policy or plans to stop making premium payments. However, the process does have some drawbacks. Selling a life insurance policy can be costly, cause a seller to become ineligible to receive or continue receiving state or federal public assistance such as Medicaid, be subject to federal and state income tax, and eliminate life insurance proceeds that may affect the financial future of an insured’s heirs.
Cancelling or surrendering a life insurance policy is an option that may suit you if you want to tap the cash in a life insurance policy and no longer need to have life insurance. Payment of the current surrender value comes in the form of a lump-sum payment to use as you please. You should understand, however, that just as selling a life insurance policy involves costs, tax consequences and can affect the financial future of heirs, so does canceling a life insurance policy outright. For example, if the cash value is worth more than the premiums you paid, the excess may be taxable.
- Kiplinger: Tapping the Cash in Life Insurance
- Fox Business: Cash Emergency? Consider Tapping Life Insurance Policy Instead
- American Institute of CPAs: Life Insurance Policy Loans: Tax and Other Implications
- The Financial Industry Regulatory Authority: Seniors Beware: What You Should Know About Life Settlements
- Ameriprise Financial: Tax Planning Tips: Life Insurance
Based in Green Bay, Wisc., Jackie Lohrey has been writing professionally since 2009. In addition to writing web content and training manuals for small business clients and nonprofit organizations, including ERA Realtors and the Bay Area Humane Society, Lohrey also works as a finance data analyst for a global business outsourcing company.