Converting Life Insurance into Income

Cancer and its treatment can leave a survivor with a need for more income due to financial concerns. During a time of financial need, you might consider using your life insurance policy as a source of income. However, converting life insurance into income is a complex matter. Before you decide to make changes to your life insurance coverage, it is important to understand the specific rules and regulations that apply.

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Converting Life Insurance into Income: Detailed Information

This information is meant to be a general introduction to this topic. The purpose is to provide a starting point for you to become more informed about important matters that may be affecting your life as a survivor and to provide ideas about steps you can take to learn more. This information is not intended nor should it be interpreted as providing professional medical, legal and financial advice. You should consult a trained professional for more information. Please read the Suggestions and Additional Resources documents for questions to ask and for more resources.

Cancer and its treatment can leave a survivor with a need for more income due to financial concerns. Although a life insurance policy is usually purchased to pay a specified amount of money to the named beneficiary or beneficiaries after you die, there are also a number of ways that income can be obtained while you are living.

During a time of financial need, you might consider using your life insurance policy as a source of income. However, before you decide to make changes to your insurance coverage, it is important to understand the specific rules and regulations that apply. Converting life insurance into income is a very complex matter. Be certain to discuss your specific needs and the options that are available to you with your policy administrator, a tax planning professional or someone who is knowledgeable about life insurance policies and financial planning.

Before deciding to use your life insurance for extra income, talk with family and close friends. There may be other options to help you obtain more money, such as through a personal loan or the sale of something you own. Also, if you qualify, there may be financial assistance through a variety of government or nonprofit programs. For example, some programs help people obtain health care services and/or prescription medications at reduced rates or no cost, depending on the level of need.

This document provides an overview of how various types of life insurance policies can be converted into income including:

• Understanding the types of life insurance policies
• Understanding methods used to convert life insurance into income
• Obtaining a loan using your life insurance policy
• Using your life insurance policy to access accelerated (living) benefits
• Selling your life insurance policy (viatical and life settlements)
• Terminating or surrendering your life insurance policy for cash
• Considerations when converting a life insurance policy into income
  

Understanding the Types of Life Insurance Policies

When considering the possibility of converting some or all of your life insurance into income, you must know what your life insurance policy will allow. First, identify whether you have a group certificate or an individual policy. Group life insurance policies are offered to people who belong to a specific organization, such as an employer, association or union. Individual life insurance policies can be purchased directly from an insurance company or through an insurance agent or broker. They are available to those individuals who meet the insurer's guidelines and pay the required premiums. With a group plan, the policy is issued to the group and a certificate is given to the individual members as proof of coverage.

Next, find out what kind of life insurance policy you have. There are many types of life insurance policies, but they typically fall into two categories: permanent insurance and term life insurance. Your policy or certificate document will specify the type of policy you have and describe the options that are available for converting your life insurance into income. The following is a general overview of the types that fall within these two categories:
 
1. Permanent  Life Insurance

Permanent life insurance provides coverage throughout your life regardless of your health condition. These policies are typically much more expensive than term life insurance policies. However, the premiums for a permanent life insurance policy remain at the rate that is stated in the policy. This type of policy cannot be cancelled as long as you pay the required minimum premium payments on time.

Permanent life insurance premiums accumulate a cash value that can be used as a loan source. Cash value is the amount of cash that has built up in your policy that you may borrow against. The cash value is different from the policy's face value (the amount of money that will be paid at death or when the policy matures). The cash surrender value is the amount that the life insurance company will pay out, after all premiums and outstanding loans against the policy have been paid, if a permanent life policy is ended early.

The following are types of permanent life insurance that are available:

• Universal (Adjustable or Flexible Premium) Life Insurance

Universal life is considered to be permanent insurance because the policy cannot be cancelled if you make the required minimum premium payments. This type of policy also offers flexibility because you can arrange to pay less than the full premium amount and keep your insurance at a lower coverage level.

During a financial emergency, it may be possible to arrange to deduct the required premiums from the cash value of the universal life insurance policy to keep the coverage in effect. However, if you do pay premiums this way, be certain to monitor the policy to ensure that there is enough cash value remaining in the policy to cover the required premiums. If there is not enough cash value, the life insurance policy could lapse and be closed by the insurer.

Some universal life insurance policies allow you to arrange to increase the amount of insurance benefit by paying higher premiums if you can furnish evidence of continued good health. If this option is of interest to you, contact your insurer to find out exactly what your policy allows.

• Whole (Ordinary) Life Insurance

Whole life insurance has cash value that allows you to borrow from the policy while you are living. While borrowing can lower the amount your beneficiary will receive when you die, it provides an extra source of money if you need it. The premiums for a whole life insurance policy vary by age and are stated in the policy. The premiums stated cannot be changed unless the owner requests an increase or decrease in the amount of coverage, and the insurer accepts the request.

• Guaranteed Issue Whole Life Insurance

Guaranteed issue whole life insurance does not require a health exam, and some policies are issued with no questions asked as soon as the premium is paid. However, some insurers may not issue a policy to an individual who is confined to a medical facility or nursing home or to someone who has an illness that is expected to be terminal within two years. Since evidence of insurability is not required, this type of policy is generally more expensive and the amount of coverage is limited.

Guaranteed issue whole life insurance is not available in all states and premiums are typically based on age and gender. In addition, these life insurance policies may only pay very limited benefits in the initial years of the policy. For this reason, if more insurance is needed than the benefit amount offered through one policy, it may be necessary to buy multiple policies. Guaranteed issue whole life insurance is generally considered to be only for people who are otherwise unable to be insured or who did not purchase an insurance policy while they were in good health.

• Variable Life Insurance

Variable life insurance provides benefits and cash values that vary with the performance of a portfolio of investments, which may include mutual fund-like stocks, bond portfolios or accounts that guarantee interest and principal.  There are both universal life and whole life versions of variable life insurance. The cash value of a variable life policy is not guaranteed so there may be a risk that the selected investments perform poorly and cash values and benefits could decrease. If the cash value of the investment portfolio falls below the level needed to keep the life insurance policy active, additional premium payments will be required.

2.  Term Life Insurance

Term life insurance typically insures your life for a specified period of time, usually 1, 5, 10, 15, 20, 25 or 30 years. This is usually the most affordable form of life insurance; usually the shorter the term, the lower the cost. Most term life insurance policies do not build cash value and your policy coverage ends if you stop paying premiums.

Some term life policies include a provision that allows you to purchase an option to convert the policy to permanent life insurance. If conversion is offered as an option, it must be selected within a specified time after the policy is issued or before you reach a certain age. You may also be able to renew your policy for an additional term, but the renewal will usually require that you provide the life insurance company with updated health information that may include a physical examination. If you are at a high risk for certain conditions, such as a second cancer or recurrence, the insurance company may not be willing to renew your policy.

Understanding Methods Used to Convert Life Insurance into Income

The most common methods for converting life insurance into income are:

• Obtaining a loan using the life insurance policy as security for the lender
• Accessing accelerated (living) benefits
• Selling a life insurance policy (viatical and senior or life settlements)
• Terminating and surrendering your life insurance policy for cash

1.  Obtaining a Loan Using Your Life Insurance Policy as Security

You may be able to obtain a loan through the insurance company that wrote your life policy, from the policy's beneficiary or from another lender by using your life insurance policy as security. When a loan is given against a life insurance policy, the lender usually expects to be repaid from the policy's death benefit after the policyholder dies, and you would not typically be required to repay the loan during your lifetime.

Loan from the life insurance company:

If you have a permanent life insurance policy, you may be able to obtain a tax-free loan through the insurance company with no questions asked about your health or finances. By using your policy as security, the loan is backed by your assets to decrease risk to the lender. The amount you can borrow and the interest rate you will have to pay is specified in the life insurance policy.

When you borrow money from your life insurance policy, premiums must still be paid to the insurance company because the policy continues to exist.  If you do not pay the money back, the loan amount plus interest will be deducted from the death benefit paid to your beneficiary.

The following facts may help you decide whether you want to approach your life insurance company about a loan:
 

• You may be able to borrow from your insurance company by using the cash value in your life insurance policy as collateral to guarantee repayment. The loan must be repaid with interest or your beneficiaries will receive a reduced benefit when you die.
• Your policy will state whether the insurance company allows loans against your policy, how much can be borrowed and at what rate of interest.
• You should be able to do a simple loan transaction using insurance company forms and receive your money quickly if your policy allows loans.
• Your credit rating or other assets are not taken into consideration for this type of loan.
• Your policy may lapse (close) if the interest is not paid on the loan.
• Your policy will provide for a loan interest rate that is either fixed (will not change) or variable (likely to change). You need to know how much the interest on the loan will (or could) cost you.

Loan from a policy beneficiary or other lender:

If you have a term life or permanent life insurance policy but your policy does not allow loans, you may be able to use your life policy as security for a loan obtained through other lenders. For example, a beneficiary or other third party may be willing to give you a loan with an agreement to be repaid from the policy's death benefit (as a beneficiary) when you die.

If you are thinking about approaching a policy beneficiary or other lender for a loan, consider the following:

• You and the beneficiary named in your life insurance policy must agree on the amount of the loan and the terms of repayment.
• You will need to provide protection for the beneficiary who has given you a loan by agreeing that you will not remove his or her name from your life insurance policy. This means that you will designate an irrevocable beneficiary (cannot be changed) or assign the policy (legally transfer the policy to another person). There is also a need to agree on premium payments so the lender has assurances that the policy will remain in effect and not lapse.
• If you do not use an attorney to prepare the loan agreement, consider having the loan agreement reviewed by one before you sign the contract.

2.  Accessing Accelerated (Living) Benefits

Accelerated or living benefits are available for both term and permanent life insurance policies. This feature allows policy holders to receive money from their policies if they have a terminal illness with a life expectancy of two years or less, have a specified disease or a long-term care illness. The amount of money paid out to the policy holder, plus any applicable interest or fee, is deducted from the amount that is paid to the beneficiary when the policy holder dies.

An increasing number of life insurance companies are offering cash advances, called accelerated or living benefits, to people with shortened life expectancies, long-term care illnesses or certain diseases. Each state and insurance company has rules and regulations about what situations qualify a person for this benefit or how much money can be advanced. If your policy includes this type of benefit, the insurance company will usually require a statement from your doctor that describes your condition and life expectancy before you can use this option.

An advantage to obtaining income through accelerated benefits is that after you die, your beneficiary receives whatever money was not advanced to you. For example, if you have a $25,000 life insurance policy, and you accept accelerated benefits of $10,000, then your beneficiary will receive $15,000 when you die. On the other hand, if you sell your policy, your beneficiaries will not receive any money from your policy.

3.  Selling Your Life Insurance Policy (Viatical and Life Settlements)

The option to sell a life insurance policy to obtain income (also known as viatical settlement or life settlement) is available for both term and permanent policies. If you are considering this option, consult a tax expert about the effect that selling your policy will have on your tax situation.

Viatical settlement: A transaction in which a person with a shortened life expectancy sells his or her life insurance policy to a purchaser at a price that is less than the death benefit of the policy. The purchaser takes over paying the premiums and becomes the owner of the policy. Check with a tax professional about any impact this may have on your tax situation before selling your policy. Individuals with a life expectancy of two years or less may not have to pay taxes on money received from a viatical settlement.

Life settlement (also known as a senior settlement): This settlement is similar to viatical settlements, except that the person selling the policy does not need to have a limited life expectancy. Life settlements are most common for older individuals who have some kind of life-shortening health condition, but they are available for policyholders of any age. Taxes on life settlements can be somewhat complicated and are best explained by a professional with tax expertise.

Most types of life insurance policies can be sold. However, the policy must include a provision that permits it to be assigned (legal ownership transferred from one person to another). There are a number of variables that determine the amount of money that will be offered as a settlement for a life insurance policy. These include the age of the policy, your age, health status, type of insurance, premium amount, death benefit amount, insurer rating and your state of residence.

When you sell a life insurance policy, either as a viatical settlement or a life settlement, you collect the money you agreed to sell the policy for minus any broker fees. The buyer (business or individual who buys the life policy) becomes the owner and collects the face value of the policy when you die. Viatical settlements are usually available only to people with a life expectancy of two years or less. Life settlements are available to people of all ages and do not involve a specific life expectancy.

If you have a group life policy through your employer, the policy must include a way for you to change coverage without proof of medical insurability to an individual life insurance policy if you leave your job. If you decide to sell the policy that you obtained through your employer, the purchaser is likely to contact your employer to get more information about the policy. This means that someone that you work with could learn about your health condition.

Before you decide to sell your life insurance policy, take the following steps:

• Find out if your policy is eligible for a viatical or life settlement by contacting the insurance company or your insurance agent.
• Talk with your doctor about writing a letter describing both your health condition and your life expectancy. This type of documentation is usually requested by companies that buy life insurance policies.
• Check with your state insurance department to find out if viatical or life settlements are regulated in your state. If so, ask the department to send you contact information for licensed purchasers and brokers of life insurance policies. If your state does not require these purchasers to register, then contact the Viatical and Life Settlement Association of America for a list of their members.
• Contact several viatical or life settlements providers (companies that purchase life policies) to learn about their guidelines for buying, as well as how much they would be willing to pay for your policy. You can contact providers on your own or go through a broker. The job of a broker is to contact a number of providers to arrange the best sale of your policy. Keep in mind that a broker who represents a specific provider will usually only inform you about what is available from that provider.

Consider the following points when deciding whether or not to use a broker to sell your life insurance policy:

o If you use a broker, that person is supposed to advise you about the advantages and disadvantages of different offers and do much of the work for you. However, you or the provider who purchases your policy will have to pay the broker a fee that is typically a percentage of the sale price. This fee might be deducted from the money you receive from the sale of the policy. 

o If you do the work yourself, you do not have to pay any of the money you receive to a broker. However, contacting and dealing with several providers can be a lot of work and some of this work may be unfamiliar to you.

4. Terminating and Surrendering Your Life Insurance Policy for Cash

If there are no other ways to access money from your life insurance policy, you may decide to surrender your policy and terminate coverage. If you terminate your policy, you receive the cash surrender value described in the policy and the policy is returned to the insurance company.

The option to terminate and surrender your life insurance policy for the cash surrender value is only available for permanent policies and it usually brings you less money than the sale of a policy. No further premiums are payable, and no one receives any benefit on your death. Taxes are paid on the amount of the settlement that exceeds the amount of premiums you paid the insurance company. Unless the surrender period for the insurance policy (often several years) has already passed, you may also have to pay a surrender charge to end the insurance policy contract. This is a fee to cover the insurer's expenses for placing the insurance policy on its books.

Cash surrender may be a good option for you if you cannot continue to pay the premiums, if the policy is no longer needed or if you cannot sell it for an amount greater than the cash surrender value. However, keep in mind that if your policy is surrendered fairly soon after purchase, there may be very little cash surrender value.

Many states have laws that allow you to change your mind if you decide that terminating your policy was not in your best interest. Typically, this decision must be made within three months after you cancel your policy. Check with your state insurance commission for specific rules in your state.

Considerations When Converting Your Life Insurance Policy into Income

Before you decide to convert your life insurance policy into income, consider the effect that this may have on your benefits and financial situation. For example, if you receive a government or state benefit based on your income, such as Supplemental Social Security Income or food stamps, the money you receive from converting your life insurance policy into income could affect your ability to qualify for financial assistance programs or change the amount you receive from a government-sponsored benefit program.

There are many factors to consider when considering changing your life insurance coverage. Only you can decide whether one option will work better than the others in your situation. If you need or want money now, the only way to determine which would work best for you is to examine each alternative and compare the numbers. Take into consideration that whatever you receive now will decrease or possibly eliminate the amount your beneficiary will receive later.

This document was produced in collaboration with:

David S. Landay, Esq., author of Be Prepared: The Complete Financial, Legal and Practical Guide for Living with Cancer, HIV and Other Life-Challenging Conditions.

Works Cited

Belth, Joseph M. Life Insurance. Indiana University Press: Indiana, 1985.

Landay, David S. Be Prepared: The Complete Financial, Legal and Practical Guide to Living with Cancer, HIV and Other Life-Challenging Conditions. New York: St. Martin's Press, 1998.

"Life insurance basics." Insure.com. Life insurance basics. 24 October 2006.
http://info.insure.com/life/basics.htm

Petersen, David. Seminar: Financial Planning for People with HIV/AIDS. New York, 1994.

"What You Should Know About Buying Life Insurance." Info.gov. Federal Citizen Information Center. 24 October 2006.
www.pueblo.gsa.gov

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Converting Life Insurance into Income: Suggestions

The suggestions that follow are based on the information presented in the Detailed Information document. They are meant to help you take what you learn and apply the information to your own needs. This information is not intended nor should it be interpreted as providing professional medical, legal and financial advice. You should consult a trained professional for more information. Please read the Additional Resources document for links to more resources.

Periodically review your life insurance needs to determine whether you need to purchase a particular type of life insurance policy.

Know about the types of life insurance policies you have and what your options are to convert the policy into income.

If you decide to use your life insurance policy to obtain income, discuss your specific needs and options with your policy administrator, a tax planning professional or someone who is knowledgeable about life insurance policies and financial planning.

Identify and understand all of the financial benefits and potential effects of converting your life insurance policy into income.

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Converting Life Insurance into Income: Additional Resources

The resources listed below provide more detailed information and support services to help you with converting life insurance into income.  Please read the Detailed Information and Suggestions document for more information and questions to ask.

Click a resource for more information:

• LIVESTRONG SurvivorCare Program
• National Association of Personal Financial Advisors
• Cancer Legal Resource Center
• Life and Health Insurance Foundation for Education
• Life Insurance Settlement Association
• Federal Citizen Information Center

LIVESTRONG SurvivorCare Program
www.livestrong.org/survivorcare

LIVESTRONG SurvivorCare offers assistance to all cancer survivors, including the person diagnosed, caregivers, family and friends. The program provides education, information about treatment options and new treatments in development, counseling services and assistance with financial, employment or insurance issues. To provide these services, LIVESTRONG SurvivorCare has partnered with several organizations, including CancerCare, Patient Advocate Foundation and EmergingMed.

The LIVESTRONG Survivorship Notebook is a tool that can help you organize and guide your cancer experience. The portable, three-ring binder contains a variety of information covering a full range of physical, emotional and practical survivorship topics. You may order a free LIVESTRONG Survivorship Notebook at www.livestrong.org/notebook. Shipping and handling charges will apply.

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National Association of Personal Financial Advisors
www.napfa.org

The National Association of Personal Financial Advisers (NAPFA) is a professional organization for financial planners. Membership is limited to financial planners who charge customers a set fee rather than those who earn commissions from products that they sell to customers. From their Web site, you can find a fee-only financial planner in your area. The site also includes information about how to choose a financial planner and tips for managing your finances, as well as articles about investing, long-term care and disability insurance policies, retirement planning and more.

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Cancer Legal Resource Center (CLRC)
www.disabilityrightslegalcenter.org

The Cancer Legal Resource Center (CLRC) provides information and resources on cancer-related legal issues to survivors, their families, friends, employers, health care professionals, and others coping with cancer.  The CLRC offers information on a broad range of cancer-related legal issues, including health insurance, employment, government benefits, estate planning, advanced health care directives, family law and consumer assistance.  Through a national toll-free Telephone Assistance Line (866-THE-CLRC), callers can receive information about relevant laws and resources for their particular situation.  The CLRC volunteer panel of attorneys and other professionals provide more in-depth information and counsel to CLRC callers.  All CLRC services are free and confidential.  Services are available in both English and Spanish.

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Life and Health Insurance Foundation for Education
www.life-line.org

This Web site provides information about many different types of insurance, including life, disability, and long-term care insurance. Tools for calculating your insurance needs and tips on finding an agent are included. The site also has a glossary of insurance terms.

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Life Insurance Settlement Association
www.lisassociation.org

The Life Insurance Settlement Association is a non-profit trade association that provides information to consumers as well as to members of the viatical and life settlement industries. The LISA Web site has links to state statutes and regulations covering viaticals and life settlements, as well as a glossary of terms. You can also find contact information for life settlement brokers, providers and companies in your area.

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Federal Citizen Information Center
www.pueblo.gsa.gov

The Federal Citizen Information Center offers hundreds of booklets and fact sheets on consumer issues and government services. You can view and print information from the Web site or you can request that information be mailed to you. Some mail order requests will carry a small fee. Topics include money management, saving for retirement, investing, Social Security, Medicare, credit, consumer protection laws and more. Some publications are available in Spanish and other languages.

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