Cashing in Your Life Insurance Part 2
In last week’s article, I talked about some of the important things to consider before cancelling your permanent life insurance policy and “cashing in” the surrender value that it holds.
There are certainly some compelling reasons to think twice about cashing out the policy. The good news is that there are some alternatives to accessing some of the cash value without cancelling the policy altogether.
Option 1 – Consider a Partial Surrender
The example I used last week was for a $100,000 life policy with a $20,000 cash value. What if you need to access some money but $10,000 will do? This option generally works better with Universal Life policies and less so with Whole Life ones but could be a great way to access some of the built up cash in the investment component of the Universal plan. It’s important to consider that there will still be some taxes due on the amounts that you withdraw.
Option 2 – Take out a Policy Loan
A policy loan can often work with both Whole Life and Universal Life policies. In short, you essentially borrow money from the life insurance company and use your insurance policy as collateral. If your policy is earning enough in dividends or investment income, you may even have sufficient cash flow available to both pay the premiums and cover the loan interest. You can borrow a certain amount, up to the Adjusted Cost Base (ACB) of the policy, without triggering any taxes too. Using the above example, let’s say you borrow $5,000 against the $100,000 policy and never pay it back. If the loan interest is paid each year and the loan amount is still $5,000 when you pass away, your beneficiaries would receive the remaining $95,000 tax free.
Option 3 – Borrow from a Third-party Lender
Similar to a policy loan, you can also borrow money from a third-party lender and use the insurance policy as collateral. A bank or other lender might set this type of loan up so that you never have to pay the interest, but it is instead capitalized onto the loan. The loan value would keep increasing by the interest amount incurred each year and it would be paid off upon your death with the insurance proceeds. Any amount of insurance benefit above the loan value would still be passed on to your other beneficiaries. While a little more complex to setup, a third-party loan might offer more attractive features and interest rates vs the insurance company loan.
A partial surrender might make more sense for someone who’s in their 50s as they wouldn’t want to be paying loan interest for 30+ years. A policy loan is often the better option for someone in their late 60s or older.
Before you cancel or cash in your life insurance policy, be sure to meet with a Certified Financial Planner who can review your full retirement plans to see if other options or strategies might make more sense for you. While the big cash surrender value may look appealing, there just might be a better option to consider.