Cashing out life insurance policy: pros and cons

Some people think that once the kids have completed college or you have paid off your mortgage it is time to cancel or reduce life insurance. Baby Boomers are living longer, and cashing out life insurance can help pay off debt or provide funds for loved ones.

But before you decide to cancel your policy, take some time to carefully review your situation. Robert Quinlan, managing member of Quinlan Care LLC, offered the following tips on life insurance policies as you reach retirement age. Here is what you need to know.

Boomer: Once I reach my retirement, do I need to keep my life insurance coverage in force?

Quinlan: There are many reasons why someone should keep their insurance coverage. Did you still have debt from a mortgage, auto loan, “still too big” credit card(s) balance, or in the midst of education debt for a second career or to help educate a grandchild or child? You may not have sufficient retirement income or funds for your surviving spouse or partner to maintain their life style today after your death. Are your charitably inclined? You may wish to leave all or some of your life insurance benefits to your favorite charity, or leave it to your children.

Boomer: What is the difference between term and permanent life insurance?

Quinlan: Term life insurance is like renting a property. It will provide your beneficiary with a death benefit for a limited period of time, like 10 or 20 years with a level premium that is initially decided based on the age and the health of the insured. There is no cash value.

Permanent life insurance (i.e. whole life or universal life) provides your beneficiary a death benefit as long as you live. It also accumulates cash value that you withdraw or borrow against during your lifetime. It has a level, higher premium than term insurance.

Boomer: If I am age 60 or older and have no life insurance, which type of life insurance should I be looking at to purchase?

Quinlan: You may read this answer a lot – it all depends. Do you want protection for a temporary period of time like 10 years and you want a lower premium than permanent life insurance? Then term insurance may be right for you. If, however you want protection until you die, then permanent life insurance may be better than term. Consult with an insurance professional to help you address your situation.

Boomer: Are my beneficiaries taxed on the benefits they receive on my death?

Quinlan: No, for the vast majority of Americans who receive lump sum checks, these death benefit checks are income tax-free. If someone elects to receive the proceeds over say 10 years, most of the periodic payments will be income tax-free. However, a smaller portion of each check will be taxable (as ordinary income) due to the interest that the carrier will pay you each year that the funds remain with the carrier.

Boomer: What is the long-term care rider that can be added to my policy when completing my application for a new life insurance policy?

Quinlan: Yes, you can add this popular rider to your permanent policy at the time of application to cover the significant costs today for home care or care in an assisted living community or nursing home. You cannot add this rider after the policy was issued.

Boomer: If someone becomes terminally ill, how can life insurance help them?

Quinlan: If you are terminally ill (12 months to live or less), your policy (either term or permanent) may permit you to withdraw up to 60 percent of the policy’s face/death benefit to use it for any purpose (like what’s on your ‘bucket list” or pay any medical expenses that could extend your life longer without incurring debt) and is free of any income taxes. Read your policy to see if this provision is included, or it may be a rider to your policy today at no additional premium.

Boomer: What advice to you have for anyone uncertain about what is in their policy today, or about to buy a new policy?

Quinlan: I recently met with a financially successful woman who deposited several hundred thousand dollars into a single premium life insurance policy (creating over $1 million in death benefits at her death). She named her three grandkids as beneficiaries. Nice gift for her grandkids, right? However, she was unaware that it might have the potential to generate a hefty tax when she and her spouse die. This federal tax is called the generation-skipping transfer tax. Always sit with a knowledgeable insurance and tax professional to select and understand the best type of policy for you today and the rider(s) that will enhance your life insurance coverage.