De-cluttering your Life Insurance Options

posted in: Money Blog

Are you caught up in the tidying and decluttering trend? If so, have you reached that overstuffed financial drawer yet? Or maybe you’re dealing with your elderly parent’s cluttered financial papers.

One of the more daunting financial areas can be life insurance.

A common issue with an old life insurance policy that you or your parents have had for years, is being stuck with premium payments for a policy that is no longer relevant to the current situation.

I hate seeing people waste money. Dropping a policy (to stop the payments) without finding a way to monetize that languishing asset is a waste.   I’ve invited a guest blogger, Lingke Wang from Ovid Corp, to offer alternatives for extracting some cash from those lapsing life insurance policies.

Alternatives to Lapsing Your Life Insurance

What's the best road to financial security?
What’s the best road to financial security?

For most of us, the reason we purchased life insurance is to ensure that our loved ones are taken care of in unexpected circumstances. However, situations can change and a policy that we originally purchased many years ago may no longer be the best fit for our financial needs.

For instance, perhaps the annual premiums were once affordable, but are now too expensive for our retirement income. Or, perhaps our children, who we purchased the policy to protect, have now grown up and are fully financially independent.

We may find ourselves in a position where the policy we purchased years ago no longer fits our needs at an acceptable annual premium cost.

So what if we want to get out? Well that part is easy – you can just cancel your policy. Insurance companies love this option. If you suddenly stopped paying premiums after years of payments, they get to keep all of the money you’ve sent them but are no longer required to pay out your death benefit.

So a better question is can we get out of a life insurance policy while salvaging what we have paid in? Your options are dependent on the type of insurance you have: term, whole, or universal.

To learn what options are available to you, read through the sections below for your policy type.

Standard Term Life Insurance

If you have a normal term life insurance policy, unfortunately there is not much you can do. Term life insurance is designed for you to pay only while you need the coverage. If you find yourself in a position where you don’t want the policy anymore, your only option is to stop paying and lapse the policy.

There’s no option to salvage the value you’ve paid in unless you own what’s called a convertible term life insurance. Most term policies are not “convertible”, but you should definitely call your insurance agent just to make sure. If you own a convertible policy, you might qualify for a life settlement (read the “Life Settlement” section below), which can help you recover some of your value.

Whole vs Term Life Insurance Options?Whole, Universal, and Convertible Term Life Insurance Options

If you own a whole or universal life insurance, you likely have built up a cash value over the years. This provides you additional options that are better than just lapsing the policy:

  • Using cash value to pay premiums,
  • Taking out a policy loan,
  • Surrendering the policy.

Additionally, whole, universal, and convertible policies may be eligible for a life settlement (read the “Life Settlement” section below) which is generally the most financially optimal option for getting out of a policy.

Using Cash Value to Pay Premiums

If you’ve built up some cash value in your policy, you can actually use it to pay your premiums. Of course, this only lasts as long as you have cash value remaining. Many insurance companies will allow for this, you just have to call your agent and ask.

Taking Out a Policy Loan

Taking Out A Life Insurance LoanInstead of using the cash value to pay your premiums, you might also consider taking out a policy loan. There are some definite pros and cons with this option so you want to be sure your loan is structured properly. Essentially you borrow from the insurance company using your cash value as collateral. The interest rate for your loan is specified in your contract and is typically around 9%.

Unlike standard loans, you don’t have to pay this loan back if administered properly. The amount you owe (including interest) is ultimately deducted from your death benefit. You can use this money in any way you want, whether to pay off premiums, pay for a large expense, reduce debt, etc.

However, there are some considerable “cons” when choosing the loan. Be very careful when taking out a loan. You will still have to make interest and premium payments. You can structure it in a manner where your cash value and dividends pay for this amount so it doesn’t come out-of-pocket. However, if the loan is not structured properly, or if you live longer than expected, the interest and premium expenses can consume all of your cash value and cause your policy to lapse.

If you have a loan outstanding while the policy lapses, it may result in a taxable event which can be especially dangerous if you are not prepared for such a situation. If you are considering this option, make sure you speak to your insurance agent and a financial adviser to be sure the loan is structured properly and that you understand all of the risks.

Surrendering the Policy

You have a right to cancel your policy...Surrendering your policy is the process by which you cancel your policy and withdraw your full cash value. Most insurance companies will charge a surrender fee which you should take into account. Finally, the cash you get from surrendering a policy is a taxable event. Be sure to consult a tax adviser to discuss the implications.

If you are considering this surrendering option, be sure you explore the next option, life settlements, which is generally a better financial option for salvaging more value from your life insurance policy.  

Life Settlement

Whole, universal, and convertible term life insurance policies can qualify for a life settlement. A life settlement is a transaction whereby you sell your policy’s benefits to an institutional investor. Upon completion of the sale, you receive an upfront cash payment for the policy. The amount you can receive in a life settlement is on average 20%-25% of your policy benefit but depends on various factors such as age, health, and policy size. Afterwards the buyer is responsible for paying the premiums and will receive the final death benefit. Similar to a surrender, the sale is taxable and you should consult a tax adviser to discuss the financial impacts.

In order to qualify for a life settlement, you must generally be at least 65 years old and have a policy value of at least $100,000. The age restriction can be relaxed if you are in declining health. The net result of a life settlement is essentially the same as a surrender except that you can usually receive more cash in a life settlement. You can get a quick and free estimate of how much you’d receive using Ovid’s life settlement calculator.

If you are interested in learning more, read about Ovid’s life settlement process.

Summary

In conclusion, it’s important to remember that your life insurance is an asset – just like a house or a car. If you no longer want to continue paying the annual premiums to keep the policy in force, make sure you explore all the options before you just decide to cancel the policy. Depending on what type of policy you have, you may be able to extract significant value from it instead of just giving it back to the life insurance company.

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Lingke Wang of Ovid Corp. contributed to this article

Ovid Corp. is the leading life settlement exchange, where consumers can sell their unneeded life insurance policies through an auction to institutional investors. As of October 2015, Ovid is available in CA, MI, MO, AL, DE, NM, SC, WY, and DC and is quickly expanding to other states. For more information about Ovid please visit www.ovidlife.com or call us at 800-311-OVID.