If you have an old life insurance policy and you no longer need the life insurance, don’t just stop paying the premiums and let it lapse – it may be worth something. Many people are surprised to learn that there are several options available, depending on the type of insurance. Before you get rid of any policy, you do want to make sure you’ve determined how much life insurance you need. To figure this out, we really like the calculators on LifeHappens.org.
Once you’ve decided you really don’t need a life insurance policy anymore, then you’ll need to determine the type of policy to figure out your options. Most life insurance can be classified as either term or permanent.
Term insurance is designed to cover you for a period of time (like 20 years) and typically has a fixed premium for that period. At the end of that period, it will typically convert into yearly renewable term and become dramatically more expensive.
Your options when your term is up
- If you don’t need the insurance, drop it – there is no value there to recoup.
- If you need the insurance, see if your policy allows you to convert all or part of the death benefit to a whole life policy – this can help you keep some in place without having to pay the higher premiums.
Permanent insurance can mean a Whole Life policy or a Universal Life policy – both are designed to cover you permanently (aka for your lifetime) as long as you keep the policy in force. In the earlier years of these policies, keeping it in force typically means paying the premiums, although there are ways a policy can be fully paid-up or begin paying for itself.
That’s because these policies also build up a cash value over time and that can provide you some options if you no longer need the insurance in place. If you own a Whole Life or Universal Life policy and find that you can no longer afford the premiums or you simply don’t have a need for life insurance anymore, before you let the policy lapse, make sure you explore your options.
Your options for a permanent policy
- You can surrender the policy – Also sometimes called “cashing out,” this is when you ask the insurance company to pay you whatever the cash value is, then the policy is canceled. The difference between what you paid in premiums and the cash value (aka if you made money over the years) is subject to income tax.
- You borrow against the policy – This is a key feature that many insurance salespeople use to sell policies – this is a way to get at the cash value of your policy without taxes and while keeping the policy in force. The main downside of this is it may result in a taxable event if the policy lapses and what you paid in premiums is less that the amount you borrowed.
- You can do a 1035 exchange to an annuity – The phrase “1035 exchange” references the tax code that allows for this. You basically use the cash value of your policy to buy an annuity that will pay out to you during your lifetime, rather than waiting until you pass for the policy to pay out. There are no tax implications to do the exchange and your cost basis (premiums paid) carries over. Your distributions from the annuity, whether an immediate income annuity or a deferred annuity, are taxable as they come out.
- You can do a viatical settlement – That is where the owner of the policy (usually you), sells the policy to someone else (either a person or a business) for an amount less than the insurance face value. For example, if the new owner changes the beneficiary to themselves, then they get the death benefit when you die. You would pay income tax on the difference between what you paid in premiums and what they paid you for the policy. (You may qualify for tax-free income if the insured person has less than 24 months to live.)
The bottom line is don’t treat 30 year-old insurance policies like 30 year-old ties. Old life insurance policies may have some value left and can be a way to access money you didn’t even realize you had.