As a responsible young adult, you bought a life insurance policy to protect your family in case you died. But that was a couple of decades ago — and you’re still paying an annual premium. Now your situation has changed, and it may be time to re-examine some old decisions. For example, maybe your spouse passed away so you don’t need to provide for him or her, and the kids are doing very well on their own, but your cash needs are starting to become a concern. That life insurance policy is a financial asset that you can tap for cash — but you need to consider the consequences.
“Using that life insurance policy as a financial instrument can cover living expenses, nursing home care or other expenses,” said Amy Danise, editorial director of Insure.com, an insurance resource.
Three Ways to Access the Cash
There are three primary ways to draw cash from universal and whole life policies (but not term policies): you can take the cash value out of the policy and let the insurance lapse; you can take out a loan against the death benefit; or you can sell the policy as a life settlement. “The first question to ask yourself is do I need a death benefit?” said Michael Kitches, director of research at the Pinnacle Advisory Group. “If I die, does my family need that money? If you need that death benefit, don’t mess around with the policy.” If not, Kitches says it may be a reasonable option to use the policy to cover your immediate needs.
The most controversial option is a life settlement sale.
Cash-value whole life and universal policies give you the opportunity to take partial withdrawals of the money you’ve paid in over the years, keeping part of the death benefit intact. You can also take out all of the cash value that’s built up by surrendering the policy. But if you surrender it, you can’t get your policy back. It’s also important to note that a cash withdrawal can be taxable beyond your cost basis, while a loan is not. However, a loan will have to be paid off with interest by you or your heirs. “If you take a $50,000 loan, the insurance company will use your life benefit as collateral,” according to Kitches. “It gets paid back on the loan by reducing the death benefit paid to your heirs.”
The most controversial option is a life settlement sale. This allows you to sell your policy, usually to an institutional buyer. It can provide you with more cash, but for some people there’s a “yuck” factor. Basically, you are selling the death benefit in your policy to strangers who are rooting for you to die sooner rather than later. They pay the annual premiums as long as you’re alive, and they collect when you die. Danise says this is the “polar opposite” of buying a life insurance policy. When you buy a policy, the insurance company benefits if you live a long life. Here, the buyer of your policy profits from your early death. “How do you feel about investors profiting from your earlier demise?” asks Danise. “I don’t like it personally, but we can throw those ethical questions out the window if you need money later in life.”
Life Settlement Brokers
Kitches notes that sellers are likely to get substantially more money from a life settlement than they would by simply surrendering their policy. You generally need to be at least 62 years old, and the worse your health, the more money you’re likely to get. If you are interested, Kitches suggests searching online for life settlement brokers who will bid out your policy to institutional buyers. He says they will give you a quote, or reject you for being too healthy.
In general, insurance experts say your first choice should be to keep the life policy for your family, but if you face a cash crunch to pay your bills, tapping your policy might prove to be a life saver.