The Visible Policy
Page 9, Without Even Dying!
It is important to realize that there may be tax or other consequences
resulting from any of the actions below. Speak with your agent
and/or tax counselor before doing any of them.
The primary purpose of life insurance is to provide for one's beneficiary
upon death. Still, my participating whole life policy offers other
benefits as well. Over time, it even becomes an accessible financial
investment. Most of The Visible Policy
has assumed the policy
would be kept until death or maturation, but this is not necessary
to obtain significant value out of it.
Here are some of the ways to access the cash value associated with the
- Let the Policy Lapse or Mature
"Lapsing" the policy means dropping it. It can be lapsed either by
request or by failure to make required payments. If the policy is
held until it matures, then it automatically lapses. (At that point
cash value and death benefit will be equal.) Either way, insurance
protection ceases and the cash value, less any outstanding loan principle
and interest, is transferred to the policy owner.
On an older policy, this may be a lot of money to receive in a single
year. Any amount over cost basis is
taxable that year as ordinary income. On a younger policy, the cash
value is probably below cost basis, so lapsing it in that case will not
result in a tax burden.
(You will just have paid for some very
expensive life insurance. If you don't plan to keep the policy at
least until cash value is greater than what you paid for it, you may as
well have bought a term policy.)
My policy matures at age 100. I have heard of permanent policies
designed to mature anywhere between 85 and 120. In general, the younger
the age of maturation, the higher will be the premium payments.
The scales are balanced, though; cash value gained per year will generally
be higher when the maturation age is lower.
- Surrender the Policy for Alternative Insurance
If payments have become a problem and the policyholder needs insurance
more than the cash value, he generally has other tax-free options.
On my policy, I can:
- convert it to "extended insurance". This is a
term policy with coverage for multiple years, perhaps a dozen or more.
The coverage period is based on the policyholder's age and the policy's cash
value. The death benefit (DB) remains the same as it was when the
- convert it to "paid-up insurance". It remains a whole life policy
eligible to earn dividends and be used for a policy loan.
The policy becomes fully paid for, with no more premiums due.
Its DB is based on cash value and the policyholder's age.
It will be less than the DB for extended insurance, but it can last for
as long as the policyholder desires.
In either case, the option to lapse the replacement policy remains.
The ability to directly acquire its cash value is not lost. However,
the final surrender amount will be decreasing over time on the extended
insurance, but increasing over time on the paid-up insurance.
- Partial Withdrawal
On permanent policies of which I am aware, there is an option to withdraw cash
value. With one exception, the money received from withdrawals are
considered income once the total amount withdrawn exceeds what was paid in
(cost basis). The exception is if the amount withdrawn will be
used directly by the insurance company to make a premium payment, then
that withdrawal will not be subject to taxation.
For my participating whole life policy, I can make withdrawals by selling
back paid-up additional insurance (PUA). This is a common method of
minimizing total out-of-pocket expense for the policy. However, doing so
significantly reduces both long-term death benefit and long term cash
value. Thus if one can afford to pay a bit more, it is better to keep
paying premiums until the dividends are high enough to fully pay the
- Policy Loan
Most permanent insurance allows policy loans to be taken, using the policy
as collateral. You might view this as them loaning you your own money,
but legally that is not what is happening. For a complete description
of policy loans regarding my policy, see here.
Loans are not taxed as income. You can generally keep the loan for
as long as you like, so long as interest payments are made. The policy
itself can make interest payments, but if cash value building up within the
policy is not high enough, eventually the policy will be terminated.
Once terminated, any outstanding loan balance which exceeds cost basis
is considered income. If the insured dies with an outstanding
loan, his estate will not be charged with these taxes. However, the
death benefit received by his beneficiary will be reduced by the amount of
the outstanding loan, plus any interest due.
Some policy loans, such as those on participating whole life, continues to
gain value on the loaned-out principle. The loaned money is still earning
dividends within the policy. Of course, the interest you must pay on
the loan exceeds what you are earning. Still, the effective
interest rate (taking into account both effects) can be quite low.
If one has a policy loan, he should at least try to make interest payments
with out-of-pocket money. This way the policy will not eventually
- Third Party Loan
A cash-value insurance policy can often be used as collateral for a loan from
a bank or other lending institution. The only advantage I can see in
getting this kind of loan is that you are "forced" to make regular payments
to pay it back. People who tend to let "things slip" may be helped
by this extra discipline. However, failure to pay the lending institution
could lead to loss of your policy.
- 1035 Exchange
Direct access to the cash value of a policy often exposes at least part of
it to taxation. However, the IRS allows the cash value within a life
insurance policy to be used to help purchase another insurance product
(a different life insurance policy, an endowment, or an annuity).
Doing so is considered an exchange, and the cash value is not subject to
The exchange need not be to another product from the same company. One
can acquire the new contract from any qualified vendor. Note that the
insured cannot change. I.e., Joe cannot exchange his policy for one
on his daughter, Jill.
Also note, depending on the contractual provisions of the current
policy, not all of the cash value is necessarily available. You might
only have access to the policy's cash surrender value. The
difference would be kept by your original insurance company. Similarly,
the new contract (especially if it is still life insurance) will have heavy
fees during the first one or two years — just like you paid on your
I may consider a 1035 exchange to an annuity at some point down the road.
If, say, I am in my 80's and have no further need for life insurance, accessing
the funds via an annuity can provide a stable income. As money is
drawn out, it may be subject to taxation, but the entire cash value will
never be taxed in a single year.
Not Yet Dead
Reasons may arise to give up the policy to a trust, other person, or
organization. The cash value policy will still exist, but policy
ownership is sacrificed, either for tax or health reasons.
- Irrevocable Life Insurance Trust
The beneficiary of a life insurance policy receives the Death Benefit (DB)
free of income tax. However, the DB is considered part of the
deceased's estate. If the person were wealthy enough, the entire estate
may be worth enough that it is subject to estate taxes. This includes
the Death Benefit.
If the owner (who is often also the insured) were to place his policy in an
Irrevocable Life Insurance Trust, it is no longer belongs to
him. Upon the insured's death, the DB will not be part
of the estate, and may pass to the beneficiary free of estate taxes.
There is a significant trade-off, however. The owner permanently gives
up control of the policy and access to its cash value. He cannot even
change the beneficiary of the policy.
Establishing such a trust is a legal action and should not be
done without receiving detailed advice. As the name states, the
trust is irrevocable — be sure you fully understand the benefits
- Viatical Settlement
Our medical technology can be a mixed blessing. Sometimes it can inform
a person that he is going to die within, say, the next year, yet not be able
to provide a cure. A person with cancer, AIDS, or other diseases
may face this dilemma.
If this person has life insurance, it is often possible to sell the policy
to a third party. That person or organization becomes the beneficiary
and owner of the policy. The insured might receive from the sale a
sizeable portion of the death benefit while still living. The
original beneficiary will get nothing.
Some modern policies even have viatical riders, wherein the insurance
company itself will essentially buy back the policy under certain
circumstance. Mine does not have this rider,
and I pray I am never faced with a situation where such choices need be
If it is a permanent policy many years old, an alternative would be to
consider accessing the cash value via a policy loan or partial
withdrawal. The original beneficiary could still be
able to benefit, and the insured receives funds to help him handle his
This topic is of such a serious nature, I feel unqualified to provide the
thorough information needed. Here is a
to viatical information from the Iowa Insurance Division. More
information can be found via this consumer-info
viatical category at the Open Directory Project.
Accesses since 2 September 2002
last modified 22 November 2010
© 2002 - 2010 by Rich Franzen
Rich's Home Page
No content within The Visible Policy has been approved,
authorized, or verified by New York Life or any of its representatives.
I have attempted to fairly and accurately portray the policy, but there are
likely to be mistakes. Over time, I shall endeavor to correct any
misinformation found herein.|