Some types of life insurance have a valuable special feature. Most whole life, universal life or variable universal life insurance carry a cash value in addition to being payable at the time of death. If your life insurance policy has cash surrender value, you can usually withdraw the cash, use it to secure a loan or sell it at a profit.
Cash Withdrawal
Not all types of life insurance policies have a cash surrender value. Those that do allow you to trade in the policy for cash. The cash surrender value may be more than you've actually paid into the policy, but most policies that can be surrendered for cash have a variable surrender value that begins low and only becomes significant after several years.
Taxable Income
The money you pay in premiums toward a life insurance policy is after tax dollars. For this reason, proceeds you receive from surrendering a policy are not taxed, as long as they are below your cost basis. Your cost basis is the amount you've paid less any dividends received or previous withdrawals you've made. Up to the basis, you've already paid tax on the money. Cash received in surrender beyond your cash basis is taxable income.
Financial Planning
One popular financial planning strategy is to secure real estate holdings with life insurance policies. The policy essentially is designed to pay off the mortgage of a certain piece of property in the event of your death. This allows your survivors to continue earning income from the property or sell it free and clear. If, during your lifetime, the outstanding balance on the property is less than the cash surrender value of the insurance policy, you can cash in the policy and pay off the mortgage yourself.
Other Alternatives
Another way to tap the cash value of a life insurance policy is to take out a loan against the equity in your policy. This allows you to get the money now without actually affecting the value of your policy. Because the loan is secured by the policy, the interest rate is lower than a normal loan. But if you fail to pay, the policy can be repossessed and liquidated. Another option is to instruct your insurer to use the cash value of the policy to make the ongoing premium payments. Though you don't actually receive the cash, not having to make the premium payments frees up other money without jeopardizing the viability of the policy.
Settlement
An alternative to surrendering a life insurance policy for its cash value is life insurance settlement. A marketplace for life insurance policies exists that could get you several times more than the cash surrender value for your policy. If your policy is deemed to be a good investment, a buyer will pay you cash for the right to take over the payments on your policy and receive the benefits when you die. This option usually is only available to people over 65, but it can be an effective way to finance retirement.
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