What to Think About Before Converting a Life Insurance Policy
- Know about the types of life insurance policies you have and what your options are to convert the policy into income.
- Discuss your specific needs and options with your policy administrator, a tax planning professional and/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.
- Consider that whatever you receive from a life insurance policy now will decrease, or possibly eliminate, the amount your beneficiary will receive later.
Talk with loved ones and close friends before making the decision. There may be other options, such as a personal loan or the sale of something you own. You can also find out about Federal and State Benefit Programs. For example, some programs help people obtain Health Care Assistance for Uninsured.
Understand Your Life Insurance Policy
Your policy or certificate document will specify the type of policy and describe the options available for converting your life insurance into income. Here’s what you need to know:
Do you have a Group or Individual Life Insurance policy?
- Group life insurance policies are offered to people who belong to a specific organization, such as through an employer, association or union. With a group plan, the policy is issued to the group and a certificate is given to the individual members as proof of coverage.
- 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.
Do you have a Permanent or Term Life Insurance policy?
- Permanent life insurance provides coverage throughout your life regardless of your health condition. This type of policy accumulates a cash value, which can be used as a loan source or collateral for a loan.
- Term life insurance typically covers your life for a specified period of time, usually 1, 5, 10, 15, 20, 25 or 30 years. Most term policies do not build cash value but can still be used to convert to income.
Here are some common methods for converting life insurance into income:
Get a Loan From Your Life Insurance Company
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 policy holder dies, and you would not typically be required to repay the loan during your lifetime.
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. The amount you can borrow and the interest rate is specified in the life insurance policy. You must continue to pay premiums.
Issues to consider:
- The loan must be repaid with interest or your beneficiaries will receive a reduced benefit when you die.
- 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.
- You must page the loan interest or your policy may lapse (close). Your policy will provide for a loan interest rate that is either fixed (will not change) or variable (likely to change). Find out how much you will be paying in interest.
Get a Loan From Other Lenders
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 from 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).
Issues to consider:
- You and the beneficiary named in your life insurance policy must agree on the amount of the loan and the terms of repayment.
- To protect the beneficiary who will give you the loan, you will designate an irrevocable beneficiary (cannot be changed) or assign the policy (legally transfer the policy to another person). You’ll also 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.
Accelerated (Living) Benefits
Available for both Term and Permanent life insurance policies, accelerated benefits (or living benefits) are like cash advances. They allow you to receive money from your policy if you:
- Have a terminal illness with a life expectancy of two years or less.
- Have a specified disease.
- Have 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. Accelerated benefits could also eliminate or reduce your premiums while maintaining the policy status.
Issues to consider:
- An advantage to accelerated benefits is that your beneficiary receives whatever money was not advanced to you.
- On the other hand, if you sell your policy, your beneficiary typically will not receive any money.
Sell Life Insurance Policy (Viatical and Life Settlements)
Selling a life insurance policy to obtain income (also known as viatical settlements or life settlements) is available for both Term and Permanent policy holder. To learn about this option, contact someone experienced in the valuation of a life insurance policy, such as a life settlement broker or possibly the insurance company or your insurance agent. Consult a tax expert about the effect that the following options will have on your tax situation.
Viatical settlements are transactions in which a person with a shortened life expectancy sells his or her life insurance policy at a lower price than the policy’s death benefit but greater than the cash surrender value. The purchaser takes over paying the premiums and becomes the owner of the policy.
Life settlements (also known as a senior settlements) are 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.
In order to be sold, the policy must include a provision that allows it to be assigned (legal ownership transferred from one person to another). The amount of money for a settlement for a life insurance policy depends on:
- Age of the policy.
- Your age.
- Health status.
- Type of insurance.
- Premium amount.
- Death benefit amount.
- Insurer rating.
- Your state of residence.
Your state insurance department may be able to send you contact information for licensed purchasers and brokers of life insurance policies. Or you can contact the Life Insurance Settlement Association for a list of their members.
Issues to consider:
- If you decide to sell a policy you obtained through your employer, the purchaser is likely to contact your employer for more information. This means that someone you work with could learn about your health condition.
- The buyer (business or individual who buys the life policy) becomes the owner and collects the face value of the policy after death.
- You’ll need to contact several viatical or life settlements providers to learn about guidelines for buying and how much your policy would be worth. Do this on your own or through an insurance broker, for a fee.
Terminate and Surrender 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. You’ll receive the cash surrender value described in the policy. Available for Permanent policy holders.
This option usually brings less money than the sale of a policy. Premium payments end, and no beneficiaries are named. Taxes are paid on the amount of the settlement that exceeds the amount of premiums you paid the insurance company. You may also have to pay a surrender charge to end the insurance policy contract. Cash surrender may be a good option for you if:
- You cannot continue to pay the premiums.
- The policy is no longer needed.
- You cannot sell it for an amount greater than the cash surrender value.
Issues to consider:
- 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.
Donating Your Life Insurance Policy
As a last option, you might consider donating the policy to a qualified organization, which could result in an income tax deduction for you. Discuss your specific situation with a tax-planning professional. This can be a complicated and unlikely scenario. Also talk with your chosen charity, as not all charities can or will accept life insurance as donations.
Before Converting 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.
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. Keep in mind that whatever you receive now will decrease or possibly eliminate the amount your beneficiary will receive later.
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