How to Cash In Life Insurance - Brief Article

Kiplinger's Personal Finance Magazine, May, 1999 by Kimberly Lankford

To wring money from a policy you don't need, try these strategies.

Take this pop quiz to see if you're in line for some serious dough: 1. Does anyone else depend on your income? 2. Do you expect to have an estate-tax bill? 3. Do you own a cash-value life insurance policy?

If you answered no to the first two questions and yes to the third, you may want to know the answer to this question: What's the best way to get the cash from the policy?

You have a slew of complicated options that can help you avoid taxes on your payout: borrowing from the policy, making a tax-free exchange into an annuity, withdrawing a little at a time. But in most cases, the simplest method is best: Cash out the policy.

If you cash out your life insurance policy, you'll owe income tax on any amount you receive above what you paid in premiums. But "it's unusual to see someone owe taxes," says John Hixson, a financial planner from Lake Charles, La. Because most policies are loaded with front-end fees, it can take 12 to 15 years before the cash value is greater than the premiums paid, says Hixson.

With a universal or variable universal life insurance policy, you can withdraw up to the amount of premiums paid without owing taxes. And with whole life--for which you have to cash in the entire policy--your tax bill may not be as steep as you think because, as with any life insurance policy, you're taxed only on the earnings, not the entire cash value.

OTHER OPTIONS. If the potential tax bill seems daunting, you could borrow against most (but not all) of your cash value. If you die before repaying the loan, the amount will be subtracted from the death benefit and never taxed. But this strategy has some drawbacks: You'll owe interest on the loan and you'll still be paying for insurance you no longer need. "I can't think of a situation where the tax deferral is going to overcome the cost of the insurance," says Hixson.

Some policies let you pay interest and any premiums from your remaining cash value--eliminating out-of-pocket costs--but your policy would be in danger of "self-destructing," says Ed Graves, a professor of insurance at the American College in Bryn Mawr, Pa. If those costs nibble away at the cash value for too long, the policy may run out of money and eventually lapse--leaving you with just as large a tax bill as if you'd withdrawn the money.

You can also defer taxes and cut insurance costs by making a tax-free exchange into a variable annuity. But this strategy rarely helps if you need the money soon, says Joe Harper, a financial planner from Columbus, Ohio. You'll usually begin a new surrender period--during which you may be charged up to 9% of your principal if you withdraw money in the first seven years--and you'll have to pay a new set of annual fees. If you die with an annuity, your heirs will be taxed on the gains; they won't with stocks or mutual funds. Life-insurance death benefits are also income-tax-free.

AT YOUR SERVICE

As a customer in search of satisfaction, you may find yourself going nose to nose with a surly service rep, wandering around in a voice-mail labyrinth or growing old on hold. You deserve better. Here's how to get it:

Your flight is canceled. "instead of rushing to the ticket counter and standing in a long line, run to the telephone and call the reservation number," says David Stempler, president of the Air Travelers Association. Phone reps can help you find another flight that might otherwise fill up before you reach the front of the line. Or use your cell phone to call the airline while you're in line.

You're in a restaurant. Get the staff on your side. "Tell the servers what you like to eat and ask them to help you decide," says Chip Bell of Performance Research Associates, a customer-loyalty consulting firm. "If they get to participate, they'll work a lot harder to make sure it works."

You have a problem with your credit card. If you carry a big balance or charge a lot, you might get a fee waived, have your interest rate lowered or get other perks just by asking, says Gerri Detweiler of Debt Counselors of America. If you have your checking account or mortgage with the bank that issued your card, you have even more clout.

Let us know what strategies work for you. Send your e-mail to me at klankford @kiplinger.com. --K.L.