Many people are finding their need for cash is greater than their need for life insurance. Fortunately, there are numerous ways to get cash out of your policies.
Borrow money from a cash value policy. Proceeds from borrowing are not taxable and the interest rate on the loan is usually less than 4%. The downside is the loan will reduce the insurance proceeds received at death.
Viaticate your policy. If you are terminally or chronically ill, you may be able to receive tax-free benefits from your policy while you are alive. You are terminally ill if a physician certifies you have an illness that will result in death within 24 months. You are chronically ill if a licensed health care practitioner certifies you need assistance performing at least two specified activities of daily living.
Surrender your policy. Even if you are not ill, you can redeem your policy for cash value. You recover the premiums you paid tax free. If the cash value exceeds your premiums, you must report the excess as taxable ordinary income. If the cash value is less than the premiums paid, the cash you receive is not taxable, but you cannot claim a loss.
Sell your policy. There is an active market of independent investors and life-settlement providers who may be interested in buying your policy, even if it is a term policy. Assume you own a $1 million policy. Over 20 years, you have paid premiums of $100,000. The cash value is $130,000, but a life settlement provider has offered you $180,000. If you sell the policy, you will report an $80,000 gain ($180,000 – 100,000). The $30,000 difference between the cash value and your basis is ordinary income. The $50,000 amount received in excess of the cash value is long-term capital gain, taxed at a beneficial 0% or 15% rate.
Exchange your policy tax free for one more suited to your needs, such as one that can convert cash value to long-term care benefits.
Consider holding on to the policy. Although premium payments are not deductible and the policy proceeds are subject to estate tax (unless the policy is held in an irrevocable life insurance trust), cash value growth and proceeds received by beneficiaries at death are not subject to income tax.