A time comes when you are seriously in need of money and the only thing you have left is your life insurance policy. Or in some other cases, you may change your mind and decided you need to cash out your life insurance policy.
Yes, you can cash out your life insurance before you die.
However, cashing out your life insurance policy comes with its own consequences. When you decided to make this decision you must be ready for several financial implications towards it. These may include tax liabilities which are the most common ones.
Details on Cashing Out Whole Life Insurance Policy
If you have a good understanding of whole life insurance policy options and how they work it will be easy to understand the whole process of cashing out a whole life insurance policy.
When it comes to whole life insurance you can take one option whereby, you will receive your death benefit only. In this case, you will most certainly pay constant premiums all through all months.
However, there is a second option in which you get higher cash value with time. It is like an investment where your premiums are invested by the insurance company. This helps you to collect some good returns at the end. You also have to pay higher premiums every month.
When you want to cash out your whole life insurance policy there are 3 major methods in which you can do that. They include the following.
#1. Cash Withdrawing
Withdrawing from your cash value is rather a simple step that offers you an opportunity to quickly withdraw a certain amount of money from your cash value.
When this happens, the amount of money you withdraw majorly depends on the terms of your policy as well as you provide. This is a case where you do not want to give up the coverage. You can do this especially when you are urgently in need of money.
Here are some of the few disadvantages of this option.
- Tax implications: When you decide to make a withdraw it is obvious you will have to pay a certain amount of tax on that cash. It is always bigger especially when you withdraw within the first 15 years of your policy.
- Reduces death benefit amount: This is a very obvious case. Once you do cash withdraw from your policy it means that you are reducing the number of benefits your beneficiaries get as a death benefit. So, be advised when making any withdrawals.
- Taxes on modified endowment contracts: Once you have a policy that is under a modified endowment contract you will suffer an income tax. At the same time, you will have to pay a 10% penalty on withdrawal if you are under 59 and a half years old.
- Higher premiums: Here is how this happens. When you make withdraws, it means that you are reducing your death benefits. However, to keep the benefit value the same it means that there will be an increase in your premiums.
#2. Borrowing/Loan Method
Borrowing from your cash value is a method in which your insurer gives you a chance to borrow from your very own accumulated cash value.
However, to control this system, companies a certain minimum amount of cash value that you should have accumulated before you can start borrowing.
One of the advantages of this is that you will be getting it at very low interest rates. The main reason is that you are borrowing from yourself. However, in cases where you fail to pay in time, you will suffer some penalties which include the following.
- Taxes: This means that in case you do not pay your loan on time or end up not paying all the amount, then your balance and interest gained in the policy will suffer taxation.
- Decreased death benefit: When you end up not paying your loan in full, without a doubt your family is going to get decreased amounts of death benefits.
- Higher accumulated loans: It is important to note that these loans are like any other loans you may have. Which means that there are taxes. And as a result, the longer you take to pay your loans the more interest they gain. This leaves you with higher accumulated loan figures in the end.
#3. Surrendering Option
Surrendering your insurance policy is also another option of cashing out your life insurance policy. However, it is important to note that this option is so drastic hence you need to evaluate all the options before you come to this important decision. This is because it is a permanent decision.
How this works, it means that you are surrendering your death benefits to your insurance provider. In return, your provider will pay you for your cash value. Once you do this you will get the money but it is final. No more death claims.
Here are some of the things to note when going for this option.
- Surrendering fees: It is important to note that there are surrender fees. The earlier you surrender your policy the higher the surrender fees. Thus it is important to understand this before you surrender your insurance policy.
- Decreased payout: Reduced payout mostly happens when you had a loan before surrendering your policy. Always make sure that you have cleared your loans in good time before you decided to surrender your policy.
- Taxes: When you take this route there are some taxes. You will be taxed on any profits you make when surrendering your policy.
- No more death benefit: This is the overall disadvantage of going for surrender method. Once you surrender there will be no more death benefits.
Life Insurance Settlements
Life insurance settlements is another method through which people can cash out their life insurance policy.
However, it is not a common method since it requires a lot of work and it is not easy to do. In this method, you will be selling all the rights of your insurance policy including death benefits to a third party. This means that the new owner will also be responsible for the premiums.
One thing about this method is that you will receive your cash value payout but it will be less than when you decide to surrender the policy. The good thing, in this case, is that you can negotiate on the amount you will receive with your buyer.
Here are some few things to consider when doing life insurance settlements
- Finding the right price is a problem: This is one of the main problems that you will experience when you want to sell your policy. Finding the right person to sell to and at the right price.
- Reduces your financial security: When you decide to go this way it means you are leaving yourself and your family without any financial security since you are selling everything and you will no longer be covered.
- High fees and taxes: Commission related to life insurance settlements is always so high. They can go as high as 30% on you. There are also taxes on the money you are receiving.
- Social assistance program eligibility: For people who are benefiting from social assistance programs, this action may affect everything. You may end up losing your eligibility.
After looking at the above methods of cashing out your insurance policy, it is important to think clearly about it before you choose any of the methods.