When it comes to life settlements, one of the main questions people have is whether their whole life insurance policy is eligible for a settlement. In particular, there is a lot of confusion out there as to why whole life insurance policies appear to be less popular than term life insurance among life settlement providers. To understand the situation, it first makes sense to review how the two main types of life insurance work.
Two Main Types of Life Insurance
Term life insurance: This is what’s sometimes referred to as “pure life insurance”. You make premium payments for a given length of time (known as your “term”), and should you pass during that period, your beneficiaries get the death benefit agreed to by the life insurance company in your contract. There is no savings component outside of the death benefit, and as a result there are lower premiums.
Permanent Life Insurance: This refers to life insurance policies that combine a death benefit, with a cash value that accrues indefinitely over the long-term (as long as the insured makes premium payments to keep the policy active). The premium payments are higher, as a portion of every payment goes towards the expenses of the insurance company, and the rest goes into the savings component of the policy. There is no set term or length for this policy, so it theoretically continues over the entire lifetime of the insured. Whole life insurance, along with universal life insurance, fall under this category.
With both whole and universal life insurance policies, the accrued cash value is separate from the death benefit. Upon the passing of the insured, the life insurance company keeps the cash value, and the beneficiaries only receive the death benefit. It’s most helpful to think of the cash value as the portion the life insurance company keeps to mitigate their risk from paying out a guaranteed death benefit. While insured individuals may borrow against the cash value of their policy while alive, the outstanding loan amount is deducted from the policy’s death benefit should they pass before it’s repaid.
Cashing Out On Whole Life Insurance
In the explanation above, it should be emphasized that a policyholder may either use the living benefit (the accrued cash value), or receive the death benefit, but not the combined value of the two. It is for this reason that getting a life settlement on whole life insurance can be difficult.
Think of it this way: a life settlement is the process selling your policy’s death benefit in exchange for a portion of it in cash right now. This makes exchange with term life insurance because there is no living benefit to cash in on, and lower premium payments make the policies more appealing for the settlement providers.
In permanent life insurance police, there is a built cash value the insured can access. Therefore a life settlement often doesn’t make sense as the insured can cash out in two ways:
- Borrow against the value of the policy.
- Cancel the policy and receive the cash surrender value.
As such it is more expensive for life settlement providers to buy whole life insurance policies as they are competing with their cash value, and additionally have to pay higher premiums to the insurance company should they take over ownership of the policy. It is rare that a life settlement will make sense in this case, and typically only occurs when there is a low life expectancy for the policyholder.
Am I Taxed On A Whole Life Insurance Cash Out?
Generally no. As contributions to whole life insurance are made with after-tax money, the IRS considers this double taxing and doesn’t deduct anything should you cash out on the value of the policy.
Similarly, loans against the value of the policy are not taxed, nor is the death benefit itself. In general, insurance is funded through after-tax money and meant to provide support in the event of a tragic event, so its proceeds are not taxed.
The exception to this is if the savings component of your cash value is invested in some way to grow over time. This is often common in universal and whole life insurance, and while the funded cash value is not taxed, the additional amount gained through investment is. If it wasn’t, many could just choose to invest their money via life insurance policies and never pay the proceeds on their capital gains. Withdrawals can also be taxed if they are done within the first 15 years of the policy.
Final Notes On Selling Whole Life Insurance
If you are looking to sell your whole life insurance, it will likely be harder than selling term life insurance. However, you are able to cash out or borrow against the savings component of your policy, and this is tax free if done after the first 15 years of the policy. In select cases where the insured has low life expectancy, they may still be eligible to sell their whole life insurance.