30 April 2012 0 Comments

Show Me The Money – How To Access Cash Values In Permanent Life Insurance

I’ve outlined the different types of Permanent  Life Insurance and next I’ll be discussing when Permanent Insurance is needed.  But, first I want to address the cash value that these policies generate, how that cash can be accessed during your lifetime and what happens to it after you die.

First, the cash value after death question.  Cash values are not paid in addition to the policy’s face amount at your death.  Oh yes, by adding a rider for an additional cost you can increase the death benefit by an amount equal to the cash value, but that gets very expensive.  It’s not part of the basic policy because the purpose of cash value is to annually reduce the net amount at risk and therefore maintain a level premium as the pure cost of insurance goes up each year.

However, cash value is available during the lifetime of the insured.  One way to get your hands on the cash value is to discontinue the policy.  This is a very simple concept.  If you notify the insurance company that you want to surrender your policy, they will pay you the cash value.  Just don’t get confused between the cash surrender value and the accumulation value.  Most UL policies will show both of these accounts, but it’s only the cash surrender value that you get.

In the year the policy is surrendered, ordinary income tax will be due only if the total cash surrender value—including any loans taken against the policy—exceeds the cost basis, which is the total premium paid.  The cost of added features such as Accidental Death Benefit, Waiver of Premium, or family riders cannot be included in your cost basis.

If you’re surrendering one policy in order to replace it with another policy, you may want to transfer the cash directly to the new policy.  This is called an IRC Section 1035 transfer and it avoids any current tax and transfers premiums paid on the original policy to the new policy as cost basis.  But, that’s a subject onto itself that I’ll deal with later.

In recent years an investment opportunity has arisen where investors buy existing policies from individuals who no longer want their insurance.  If these investors are willing to buy your policy for more than its cash value, you might want to consider this.  It’s called a Life Settlement.  You are most likely not a candidate for a Life Settlement offer if you are younger than age 65, the face amount of your policy is less than $250,000 or you have more than a 10 year life expectancy.  If the total amount you receive in a Life Settlement exceeds your cost basis, any profit in excess of the policy’s cash surrender value may qualify for capital gains treatment instead of ordinary income, but check with your CPA.

In my next blogs I’ll be discussing how to access cash values when you are not discontinuing your policy.  I’ll also include some cautions on how to avoid getting hit with an income tax bill with no cash to pay for it and how to avoid inadvertently losing your policy.  

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