What you can and can’t do with your whole life insurance policy can be confusing. One of the main questions people have is, “Can I sell my whole life insurance policy in a life settlement?”
The main points of confusion center on why life settlement providers seem to prefer other types of permanent and term life policies over whole life policies.
To understand the situation, let’s review how the two main types of life insurance work.
Two Main Types of Life Insurance
There are two main types of life insurance policies: permanent life insurance and term life insurance.
If you’re interested in a life settlement, it is vital to understand what kind of life insurance you own.
Term Life Insurance
Term life insurance is sometimes referred to as “pure life insurance” because it has no other value than to provide dependents with a monetary benefit after the death of the insured.
With a term life insurance policy, policyholders make premium payments for a given length of time (known as the “term”). Terms are usually 5, 10, 15 years and so on with the longest terms being 30 or 35 years.
If the policyholder passes away during that period, the policyholder’s beneficiaries get the death benefit agreed to by the life insurance company. There is no savings component outside of the policy’s death benefit, and as a result, premiums are lower.
If the policyholder does not pass away during the term of the policy, the policy expires without paying a death benefit. Most insurance companies allow policyholders to renew their contract or convert the plan to permanent life insurance at the end of the term.
Permanent Life Insurance
Permanent life insurance does not have a set term or length. It continues over the insured person’s unless the policy is canceled.
Permanent life insurance policies 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 plan active).
Whole life insurance and universal life insurance are considered types of permanent life insurance.
The premium payments are higher on permanent life policies because a portion of every payment goes towards the expenses of the insurance company, and the rest goes into the savings component of the policy.
A cash value savings component differs in definition between policy types and insurance companies. For the most part, whole life cash values are accrued through dividends earned by the insurance company. Many universal life cash values are often supplemented by all or part of the payments the insured makes after paying up the policy.
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.
Insured individuals may borrow against the cash value of their policy while alive, and 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 with a whole life insurance policy, 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.
This is why getting a life settlement on whole life insurance can be difficult.
Think of it this way: a life settlement is the process of selling your life insurance policy for an amount greater than the policy’s cash surrender value, but less than the death benefit.
So, as the cash value of the policy increases, a life settlement makes less financial sense for life settlement providers.
A term life policy, on the other hand, is more attractive because it has no cash value and lower premium payments. These two factors make term life policies more lucrative for a life settlement company.
As we mentioned, in permanent life insurance policies, 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 a life insurance policy in several ways:
- Borrow against the value of the policy.
- Cash value withdrawal.
- Cancel the policy and receive the cash surrender value (which forfeits any death benefit for your loved ones)
As such, it is more expensive for life settlement providers to buy whole life insurance policies, They are competing with the policy’s cash value and will have the additional problem of having to pay higher premiums to the insurance company should they take over ownership of the policy.
Life settlements on whole life policies are rare. They typically only occur when there is a low life expectancy for the policy owner.
If you are older than 65 years old, your life expectancy is low, and you need cash now more than your beneficiaries need it later, a life settlement may make financial sense. This is often the case when people are facing expensive long-term care needs.
If you have a terminal illness, a viatical settlement is also worth considering.
The amount of money received in a whole life insurance settlement or viatical settlement depends on a variety of factors, including the face value of the policy, life expectancies, policy premiums, death benefit amounts, and more.
To learn more, contact your financial adviser, a life settlement broker or click the button below.
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Am I Taxed On A Whole Life Insurance Cash Out?
Generally, no. Proceeds from a life settlement are subject to income tax. 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 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 are also taxed if they are within the first 15 years of the policy’s start date.
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 can 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 a low life expectancy, they may still be eligible to sell their whole life insurance.