How to Make Money Off Life Insurance

Life insurance functions primarily as a financial safety net, providing a death benefit to beneficiaries upon the policyholder’s passing. Beyond this fundamental purpose, certain types of life insurance policies can offer financial opportunities during the policyholder’s lifetime. These policies can accumulate value, which policyholders may access or monetize under specific circumstances. Understanding these mechanisms allows individuals to consider life insurance as a versatile financial tool.

Cash Value Growth in Permanent Policies

Permanent life insurance policies have a cash value that grows over time, offering a living benefit in addition to the death benefit. A portion of each premium payment contributes to this cash value, which accumulates on a tax-deferred basis. This tax-deferred growth means that earnings on the cash value are not taxed until a withdrawal is made, potentially allowing for greater accumulation over time.

Whole life insurance is a type of permanent policy where the cash value grows at a guaranteed rate, specified at the time of policy issuance. These policies often provide a fixed premium that remains consistent throughout the policy’s life. Cash value in whole life policies can also increase through annual dividends, especially from mutual insurance companies, which can be reinvested for growth.

Universal Life (UL) insurance policies offer greater flexibility in premium payments and death benefits. The cash value in UL policies typically grows based on interest rates declared by the insurance company, which may adjust. This flexibility allows policyholders to adjust their coverage and costs as their financial needs change.

Indexed Universal Life (IUL) policies link their cash value growth to the performance of a specific market index, such as the S&P 500. While offering potential for higher returns, IUL policies often include a guaranteed minimum interest rate to protect against market downturns. They do not directly invest in the market; returns are based on index performance, often with caps or participation rates.

Variable Universal Life (VUL) insurance policies provide investment options within the policy’s cash value, allowing policyholders to allocate funds to sub-accounts similar to mutual funds. The cash value growth in VUL policies fluctuates based on the performance of these underlying investments. This type of policy carries greater risk and potential for higher returns compared to other permanent policies.

Accessing Accumulated Policy Value

Policyholders can access the accumulated cash value in permanent life insurance through various methods for financial needs. One common method is taking a policy loan, where the cash value serves as collateral. These loans do not require a credit check or formal application, with flexible repayment terms.

Interest accrues on policy loans, and any outstanding loan balance, including accrued interest, will reduce the death benefit paid to beneficiaries if the loan is not repaid. While the cash value continues to grow even with an outstanding loan, failure to repay or excessive borrowing could cause the policy to lapse if the loan balance plus interest exceeds the cash value, potentially leading to taxable income.

Another way to access cash value is through withdrawals. Unlike loans, withdrawals directly reduce the policy’s cash value and death benefit. Withdrawals are generally tax-free up to the amount of premiums paid (cost basis). Amounts above this cost basis are taxed as ordinary income.

If a policyholder no longer needs coverage, they can surrender the policy for its cash surrender value. This terminates the policy, and the policyholder receives a lump-sum payment. The cash surrender value is the accumulated cash value minus any surrender charges and outstanding loans. Surrender charges often decrease over time.

Surrendering a policy can have tax implications if the cash surrender value received exceeds the total premiums paid. Amounts received above the cost basis are subject to income tax. Consider these tax consequences before surrendering, as this also eliminates the death benefit protection.

Selling an Existing Policy

Selling an existing life insurance policy to a third party is another way to monetize its value. This transaction is known as a life settlement, where the owner receives a cash payment greater than the cash surrender value but less than the death benefit. The buyer assumes responsibility for future premium payments and receives the death benefit upon the insured’s death.

Life settlements are typically available to policyholders who are older, typically over 65, and who no longer need or can afford coverage. Factors influencing the sale price include the insured’s age, health, the policy’s death benefit, and premium costs. Policies with a death benefit of $100,000 or more are often considered.

A specific type of life settlement is a viatical settlement, for individuals with a terminal or chronic illness (life expectancy of two years or less). Viatical settlements generally offer a higher percentage of the policy’s face value compared to standard life settlements due to the shorter expected payout period. The proceeds from a viatical settlement may also receive different tax treatment, often tax-free.

The taxation of life settlement proceeds is structured in tiers. Amounts received up to total premiums paid are generally not taxable. Amounts exceeding premiums paid, up to the cash surrender value, are typically taxed as ordinary income. Proceeds above both are usually taxed as long-term capital gains.

The process of selling a policy involves providing policy information and medical records to a life settlement provider or broker. The provider evaluates the policy and health to determine an offer. Policyholders review offers and, if accepted, transfer ownership to the buyer, who pays future premiums.