One of the main tenants of financial planning is minimizing risk. Having an emergency fund is one way of doing this, as are health insurance and disability insurance. But perhaps the biggest way of minimizing financial risk for your loved ones is life insurance.
Life insurance is an absolute must for anyone with dependents, as well as for anyone with large debts (such as a mortgage) that exceed personal assets. Life insurance provides your family with a means of paying off your debts and replacing your income, if only temporarily, in the event of your untimely death.
At some point, though, your family may end up in a situation where they don’t really need the money after death – maybe you’ve paid off all your debts and left healthy savings/retirement accounts for your heirs.
Alternatively, you might need the money while you’re still living to pay for long term care or other large, unexpected expenses. Or, you might just find that your current policy is not the best for you, so you want to get out before you sink anymore money into it. In some cases, using life insurance while you are still living is both possible AND the best financial choice for you and your family.
Surrender Your Life Insurance Policy
Perhaps the most straightforward way of tapping life insurance during life is by surrendering the policy. This simply means that you inform the insurer that you no longer wish to pay the premiums (if you are still paying) and/or that you wish to “cash out” of the policy now.
This option is available on life insurance with cash value – most permanent insurance policies – you will simply receive the cash value component of the policy. Be aware that the cash value will be far less than the face value of the policy (the amount your family would receive at death). In some cases, it will actually be less than the amount you paid in premiums, particularly if the policy is fairly new. You will owe taxes on the proceeds to the extent your receipts exceed the premiums you paid in. Surrendering your cash value life insurance policy is probably the best option if you want to get out of a policy you feel is no longer beneficial to your family – you can cut your losses and move on.
Life Insurance Settlement
If the surrender value of your policy is lower than you’d like, or surrendering is not an option (as in the case of term policies), you may instead consider a life insurance settlement. Life insurance settlements are essentially selling your policy to an investment company. The company will pay a certain amount to you while you are alive, continue paying premiums as long as they are owed, and then receive the face value when the insured dies. Once again, you will not receive anywhere near the face value of the policy, but you may end up receiving more than the surrender value that the policy. As with a surrender, you will owe taxes on the proceeds of the sale to the extent they exceed your premiums.
Life Insurance Viatical Settlements
Viatical settlements are similar to life settlements, but they are designed for a certain type of insured, and specifically defined and governed by the IRS. A life insurance viatical settlement happens when the insured is terminally ill (expected to die within 24 months) or chronically ill (unable to perform certain activities of daily living). Viatical settlement payments involving the terminally ill are not taxable. Payments for policies covering the chronically ill are not taxable as long as the proceeds are used for the care of the insured. Viatical settlements may be good if a terminally ill person is not leaving behind beneficiaries or debts and wants to use the money to either enjoy the last few months or life or pay for final expenses.
Things to Consider
First and foremost, you should not use your life insurance policy during life unless a) you absolutely have to or b) your family absolutely does not need the proceeds after death. It may be tempting to cash out to take nice vacation or pay off debts, but you could leave your family in a huge lurch later on. That being said, if you are facing large medical bills, long-term care expenses, or other unexpected situations, you may not have a choice. If you think life insurance settlement is for you, talk to an estate planning attorney and accountant before making a decision. Remember that you will have tax consequences that your family would otherwise avoid (life insurance proceeds at death are usually tax-free).
Finally, realize that for most people, cashing in a life insurance policy should be a last resort. If you are young and healthy, take plans to save and invest now, so that you don’t find yourself facing this decision later!