How to Use Life Insurance To Pay Off Debt

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How much cash is your policy worth?

Many households in the United States today have large amounts of debt. Student loans, car loans, high interest rate personal loans, mortgages, credit card debt, and outstanding lines of credit can be enough to financially suffocate just about anyone.

However, there is one source of funds that many people haven’t thought of. If you own a permanent life insurance policy, then you may have a substantial amount of cash value built up inside the policy that you can use to pay off some or all of your debt load. Using life insurance to pay off debt can help you manage your monthly cash flow and give you some financial breathing room.

How much money do I have in my life insurance policy?

The first step to accessing the cash value in your policy is to find out how much you can take out in one lump sum. If your policy has been in force for less than ten years, then you probably won’t have much cash value to draw from, as most of the policy premiums during the early years are used to pay the fees and expenses written into the policy. But if you have a policy that has been in force for more than ten years, then you may be surprised at the amount of cash value that you have built up.

Finding out how much money is in your policy is easy. Simply go online and log in to your life insurance company’s website and bring your policy information up. It will tell you the coverage amount, the amount of your policy’s cash value, and also the cash surrender value. Or, you can call your carrier and give them your policy number and they can look it up for you.

How can I use the cash value in my policy to pay off debt?

There are five different ways available that you can use to access the cash value in your policy. They are listed as follows:

1. Make a cash withdrawal

The most straightforward way to get money out of your cash-value life insurance policy is to simply request a straight withdrawal directly from your policy. In most cases, policy owners can either do this online or alternatively, call the insurance company and have them either send the check or deposit the funds directly into their bank account.

Just be sure to leave enough cash value in the policy to keep it in force so that you don’t forfeit the death benefit coverage. Surrender charges and other fees may be assessed on your withdrawal, depending upon how long your policy has been in force. There may also be tax consequences.

2. Surrender your policy

If you no longer want or need the death benefit coverage provided by your life insurer, then consider surrendering your policy back to your life insurance carrier. You will receive the cash surrender value that is left after all other fees and expenses have been charged by the carrier. And as with withdrawals, there may be tax consequences.

It should be noted that surrendering your life insurance policy will impact your financial circumstances in many ways. It will also impact the financial circumstances of your beneficiaries, who will no longer be privy to receiving the policy’s face value after you’re gone.

3. Borrow from your policy

By far the most widely used method of accessing the cash value in a life insurance policy today is through a policy loan. This is because loans are the fastest way to draw money from a policy and there are no administrative fees of any kind.

There are also no tax implications because the IRS considers the loan proceeds to be a tax-free return of principal. The loan will charge a low interest rate on the outstanding loan amount.

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There is also no credit check or underwriting process for these loans the way there is with auto loans or loans for prospective homeowners because you are essentially borrowing money from yourself. There is no other third-party lender to deal with.

And in many cases, loan repayment is not required, and the insurer will charge the borrower a relatively low rate of interest on the outstanding loan balance. Just know that the balance of any outstanding loan will be deducted from the face amount of the policy at the time of your death. But there is also no medical exam of any kind required, as you already met this requirement when you first took out the policy.

Therefore, you don’t have to worry about your credit score or what’s on your credit report. And you also won’t need a cosigner to qualify for the loan. A life insurance loan is the easiest type of loan you can get. But be sure to leave enough in your policy to cover the interest being charged, because failure to do so can lead to policy lapses.

4. Sell your policy

Selling your life insurance policy will generally get you much more money than any of the other options. You can sell your life insurance policy to a qualified buyer and receive two to three times the amount of cash value in your policy as a lump sum payment up front. We will discuss this arrangement in greater detail shortly.

5. Tap into accelerated death benefits

Your insurance policy may have additional riders attached to it that will pay out some or all of the death benefit while you are still living. These riders can be triggered if you become unable to perform at least two out of the six activities of daily living, such as

  • eating
  • bathing
  • grooming
  • toileting
  • transferring
  • continence

Once they’re triggered, your policy will then pay you a monthly benefit up to the maximum amount specified in the rider or when you no longer need special care, whichever comes first. There are riders available for disability, long-term care, critical illness, and chronic illness.

Whole life insurance policies vs. term life insurance policies

In order to sell your life insurance policy, you have to have a permanent policy that has accumulated some cash value. Whole life insurance, universal life insurance and variable universal life insurance are all types of policies that can be sold.

Term life policies have no cash value component and therefore cannot be sold, unless the term policy is convertible into a smaller amount of paid-up life insurance that can be sold. But any type of permanent life insurance product is fair game for settlements. The type of life insurance doesn’t really matter as long as it has cash value.

The life insurance rates for convertible term insurance will continue to rise as you get older. If you have this type of policy, then you may be wise to convert it now and get something back from it before it becomes too expensive to renew.

Selling your life insurance policy for cash

As mentioned previously, it is possible for you to sell your cash value life insurance policy to a qualified buyer. Although this can be an individual such as a friend, relative or business associate, it most often will be a life settlement company.

Life settlement companies buy all types of life insurance policies from individuals who either no longer want or need their life insurance coverage, can no longer afford the monthly payments, or need cash now to pay for necessary expenses such as medical bills or the cost of long-term care. The money can be used for any purpose.

What's your life insurance policy worth?

This form of “withdrawal” from your life insurance policy is guaranteed to net you considerably more money than any of the other methods, except perhaps the accelerated death benefit option. (For this reason, it is wise to compare the payout the settlement company is offering you with the amount that the riders can pay out, especially if you anticipate that you will need to use one or more of those riders at some point.)

How a life settlement transaction works

Life settlement transactions are relatively straightforward in nature and can be done in as little as a few weeks to a few months, depending upon your financial circumstances and other factors. The steps that this process happens in are broken down as follows:

1. Contact a life settlement company

You contact one or more life settlement companies and tell them that you would like to sell your policy. (You have to be at least 60-65 years old with a cash value policy with a death benefit of at least $100,000 in order to qualify.) How much life insurance you have will directly impact the size of the settlement that you can get.

2. Submit your information to the life settlement company

Each settlement company will request a copy of your policy along with all of your medical records and other relevant personal information. They will use this data to compute the current market value of your life insurance policy.

3. The life settlement company will determine your policy value

Each company will then come back to you with a dollar amount of life insurance quotes that they are willing to pay you for your policy. Although these amounts will probably differ slightly, they will all most likely be in the same ballpark.

4. Evaluate your offers from life settlement companies

If you accept one of these offers, then you’ll sign the settlement agreement, which assigns the ownership of your policy to the life settlement provider. You will remain on the policy as the insured.

5. The settlement company will name itself the new beneficiary

The settlement company will name itself as the new primary beneficiary on the policy and will assume the responsibility of making future monthly premium payments.

6. You will receive a cash lump sum

The settlement company will give you a lump sum cash payout that you can spend on whatever you want.

7. The life settlement company will take over your premium payments

The settlement company will continue to pay the policy premiums for the remainder of your life. At the time of your death, it will collect the death benefit and thus recoup its premium outlay and make a profit.

Life settlement companies are often backed by wealthy individuals as well as institutional investors who purchase policies and hold them as a form of investment. Their goal is usually to acquire a large portfolio of policies so that they are diversified.

Since this transaction will also impact your finances in many ways, you should thoroughly discuss all of the possible ramifications that may arise as a result. Your beneficiaries, family members, and other loved ones should all be involved in the decision-making process.

Income tax rules for life settlements

The proceeds from a life settlement are taxed in three tiers:

  1. The total amount of premium that you paid into the policy is counted as a tax-free return of principal.
  2. Any amount that you receive in excess of premiums paid is taxed as ordinary income up to the amount of cash value in the policy.
  3. Any amount that exceeds the cash value is taxed as a long-term capital gain.

The taxation of a life settlement transaction at the state level can be a bit more complicated. The rules vary from state to state and may also differ from the federal guidelines. The tax laws in New York will differ from those in Florida or Rhode Island.

Get a free valuation of your life insurance policy

Using life insurance to pay off debt can help you to become debt-free and save money if you have had a policy in force for at least ten years. But you can get much more than just the cash value if you decide to sell your policy. This would enable you to pay off more debt and hopefully make your monthly budget easier to manage.

Consult your personal financial advisor or life insurance agent for more information on how your life insurance policy can help you to pay off your debts. Want to find out how much you could sell your life insurance for? Try our instant life settlement calculator.

Author:
Chris Granwehr is the Founder of Dawn Life Settlements and a former senior manager with Mason Finance, an industry-leading life settlement provider in California. He's a member of the Life Insurance Settlement Association, and he has a passion for empowering customers financially through a faster, easier life settlement system.