When a financial emergency occurs and you have limited resources, cash value life insurance can provide you with money for emergency expenses.
Even if you do everything by the book, a major life circumstance can happen. Whether it’s a sudden layoff during Covid-19 or an illness, having a cushion when you need it can help meet your financial obligations. A question is should you cash out your life insurance policy?
Depending on the type of policy you have in place, you may have a few options. Taking out a loan against your policy or leveraging your cash value withdrawals are two options. Other areas to explore include selling your policy or surrendering it. Some people aren’t aware that life insurance policies are like savings accounts and accumulate value over time. The cash that accumulates comes from the premiums (monthly payments) you make. However, the option you choose can come with both pros and cons.
Making a Cash Withdrawal
One of the simplest ways to withdraw from your account is through a cash withdrawal. The amount you can deduct varies depending on the type of policy you have. To make a withdrawal, contact your insurance agent who can process your claim and send your check.
A drawback is that your premiums might increase and you’re subject to a 10% penalty for the early withdrawal. That’s if you’re under the age of 59. The tax penalty is for Modified Endowment Contract (MEC) policies which are taxed similar to annuities. You’re also reducing the money that’s available in the death benefit. However, cash withdrawals are tax-free when you deduct an amount that’s less than your total payments in premiums. If your withdrawal is higher than your premiums, it’s taxed and looked at as income.
Taking Out a Cash Loan
Another option to explore if you’re having financial difficulties is a cash loan from your policy. A benefit to this is your policy’s cash value serves as the collateral. That’s helpful if you have less than perfect credit. With no underwriting or financial requirements, you also don’t have to repay the loan. In most cases, your insurer will charge interest on the loan. There’s no tax penalty and when you pay it back, you can do so from the policy’s cash value or through future premium payments. As previously mentioned, the downside is the policy’s value is lower. That’s less money your beneficiaries receive. Furthermore, if you surrender your policy or have a policy lapse, the outstanding loan amount is considered income and taxable, making this a key consideration with this option.
Selling or Surrendering Your Policy
If you cancel or surrender your policy, you can receive the cash value in a check. This is taxable income. What’s more, depending on your insurer, you might have a surrender charge penalty to pay. Another drawback is you’re not leaving death benefits to your beneficiaries. And, if you have changes in your health, it might be hard to find comparable policy terms with similar premium rates.
Another method is to sell your policy to a relative or friend. However, there are a few stipulations. You have to be age 65 or older with a minimum of $100,000 in your policy. The person buying your policy takes over the payments and their heirs receive the death benefits. A downside is your insurer might charge fees for the transaction. Talk to your tax attorney and insurance agent about life settlement questions. Depending on your age, a 401(k) loan might be a better alternative.
We hope you have found this information helpful, but it is only an overview. At Bangerter Financial, we can help you evaluate your current situation and discuss options available to you. Contact us for more information. We would be happy to assist you.