Generally, a life insurance policy is intended for your beneficiaries to receive funds after your death to replace your income or to help pay off debts or funeral expenses. But sometimes that beneficiary has to be the policyholder instead. Regardless of the reasoning behind why you decided to cash in your insurance policy, there are a few things you need to know before you proceed.
Making the Right Choice
You need to determine which type of insurance you have. There are two kinds of life insurance: term and permanent. According to the Prudential website, term insurance provides protection for a specific period of time, perhaps 10, 15, 20 or 30 years. It pays a benefit to your loved ones if you die during this time period. These type of policies typically do not accumulate a cash value, but some offer the chance to convert a term policy into a permanent policy which does accumulate value. Permanent policies offer a variety of death benefits as well, but also offer you that potential.
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Be sure you are cashing in your policy wisely. Kiplinger's Personal Finance Magazine posed a series of questions to those contemplating cashing in their policies in the article "How to Cash in Life Insurance." These questions include, does anyone else depend on your income? If so, you need to ensure that cashing in the policy is the best option for your family at this time. Can you borrow against your policy instead? Withdraw a little at a time, as needed? Or do you plan to simply cash out the policy?
In addition, LoveToKnow.com's insurance experts recommend you consider the following before cashing out your policy: If you withdraw only a portion, will the final payout be enough to help your family if you pass away in the short term? Are you creating a taxable income? Are there any penalties for your specific policy? If your policy is paid off, is there a better place to invest the money currently sitting in your policy?
Now that you've decided to proceed, determine whether to borrow or withdraw. You can take out a loan against the policy or you can simply cash out your policy and take the full amount. If you decide to take out a loan against your policy, you are generally not obligated to pay it back. However, remember that the money you borrowed, plus interest, will be subtracted from the death benefit. If you don't pay it back, your beneficiaries will lose out.
If you plan to cash out your policy instead of borrowing against it, you can make a either a full or partial withdrawal of your cash value. This, too, reduces your death benefit and in the case of universal life insurance, for example, your benefit would be reduced on a dollar-for-dollar basis.
The bottom line? Remember that if you choose to take out a loan or to cash in your policy, you can decrease or eliminate the payout to your loved ones when you die.
Remember that you'll owe income tax on any earnings that are more than you paid into it as premiums. However, financial planner John Hixon said in the Kiplinger's article cited earlier, that very few people wind up owing taxes, as many policies are loaded with front-end fees, causing policies to take more than a decade for the cash value to accumulate to be more than the premiums paid. Typically you can withdraw up to the amount of the premiums you paid in, without owing any taxes. Check with your Prudential insurance professional to ensure any taxes will be appropriately paid.
You will need to contact your Prudential estate planner to begin the paperwork and official process. Each policy through Prudential will have its own specifics and terms regarding loans and cash value withdrawals or cash outs. Make sure to compare your copy of the policy with the paperwork they send you.