11 October 2013 0 Comments

Cashing In

cashing inYou want the cash out of your life insurance policy…or do you?  Ask yourself why you want it before you make a move.  If you simply surrender your existing permanent life insurance policy and pocket the money there will be income tax due if the total cash value (including any policy loan) exceeds cumulative premiums you have paid.  If you are cancelling your current policy because you are buying another policy you can avoid current taxation by transferring the cash directly into the new policy following procedures defined in IRC Section 1035.

A section 1035 transfer can make sense, but if the policy whose cash is being transferred has a policy loan, then there could still be a tax equal to the lesser of the gain in the policy or the amount of loan forgiven. Here are a couple of situations I have seen that created a tax that could have been eliminated or reduced:

  • If the loan is from a participating whole life policy and there are paid-up additions that have been purchased by policy dividends, surrender paid-up additions and repay the loan with the cash received.  Then enter into the 1035 exchange with a reduced or eliminated policy loan.
  • If the loan is from a Universal Life policy, then withdraw enough cash sufficient to repay the loan.  If there is not enough cash to cover the loan, then continue the process by withdrawing the net cash that has just been created by repaying the loan.  This may take several transactions depending on the amount of the loan relative to the net cash, but it can be accomplished, wiping out the loan.  This same process can be used when the Universal Life policy is to be kept and you want to eliminate the interest due on a loan that would not be applicable to a cash withdrawal.
  • If you are surrendering the permanent policy with the idea of replacing it with term and there is a gain if surrendered, consider transferring the cash via a 1035 exchange into an immediate annuity with payout over a specified period of time sufficient to pay the term premium.  This doesn’t avoid tax, but it spreads it over the period of the payout.

If you simply want to discontinue the life insurance protection because you are entering your retirement years and your objectives are to reduced costs and increase retirement income, then consider a 1035 exchange to a lifetime payout immediate annuity.  This works exceptionally well when the cost basis in the life insurance policy exceeds its cash surrender value.  This is because that will be the basis for the annuity payout resulting in fewer taxes and more net retirement income.

So much to think about!  But, your life insurance is an important part of your financial plan and requires the attention of an agent who understands its potential and complexities.

Coming up…the simple power of life insurance.

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