With home equity tapped and investment yields down, some income-hungry retirees may be tempted to siphon cash from permanent life insurance policies.
The industry doesn't track the number of customers taking cash out of policies, but interest has increased, said Marvin Feldman, an agent and chief executive of the Life and Health Insurance Foundation for Education in Arlington, Va.
One client in his late 60s recently withdrew some of his cash value to pay retirement living expenses, likely giving up the death benefit for his heirs, said Melissa Millan, senior vice president for MassMutual Financial Group in Springfield, Mass. Another client, a New York business owner, used his policies to buy out partners in the business. Another small-business owner, in Tampa, used one to avoid foreclosure, she said.
Whether this is a wise move for you depends on a couple of factors, agents and consumer advocates said.
First, have your reasons for owning a policy permanently changed? Second, are you getting the best possible deal for its built-up value?
"You should really only buy permanent insurance if you're committed until death," said Scott Witt of Witt Actuarial Services in New Berlin, Wis. Witt advises clients about life insurance on a fee basis.
For people who have purchased a permanent policy, Witt said, letting the cash value grow over time is the path to getting the most from your investment, because it preserves a permanent death benefit and provides slow and steady gains.
That said, it isn't always easy to predict your cash needs decades before you have them. You might wind up in retirement and have an income shortfall that outweighs your desire to leave money to heirs, for example.
"Why did you buy the policy in the first place? Presumably, it was for your survivors," said Gerri Walsh, associate vice president for investor education for the Financial Industry Regulatory Authority. If the situation has changed, however, it may warrant taking a look at your options, she said.
Walsh urges consumers to think through their cash needs to see if there might be another way to resolve the problem if it is a short-term crunch and you still might need the policy.
Depending on how you tap the policy, there could be tax consequences and other costs that make your current crunch look a lot smaller, she said. Withdrawing cash value beyond your cost basis can be a taxable event, for example, experts said.
"Talk to your agent or the company directly and try to look at all the alternatives" before jumping in, Walsh said. "If you're borrowing against a policy for day-to-day needs, how are you going to have the resources to pay back the loan?"
Certain you want to extract some cash? Then follow these guidelines to make sure you are receiving the best deal, experts said:
Consider life settlements
If you definitely don't need the death benefit any longer, you most likely can receive more for your policy with a life settlement than if you simply terminate the policy for its cash value.
Under life settlements, people with 12 or fewer years of remaining life expectancy can sell their policies to a third-party broker, who pays the insured a higher lump sum for the policy than the cash-out value.
The key to maximizing your payout is getting several brokers into the act, Feldman said. Get competitive bids from at least four or five, he said. This will help ensure you are hearing the best offers instead of just the ones that pay the broker the highest commission.
Know the true costs
If you decide to borrow from your policy, make sure you understand the terms.
"Many people don't recognize the true cost of a policy loan," Witt said, citing the interest costs that policy owners are required to pay back to restore their death benefits.
Borrowers should avoid what's known as a "surrender squeeze," which occurs when policy loans mount to the point where the holder has to pay prohibitive interest to keep the policy in force or surrender a now-worthless policy and realize a large taxable gain, Witt said.
"The most valuable trait that a life insurance policy has is the tax-free nature of the death benefit, so policyholders should think twice about putting themselves in a position where they jeopardize their ability to maintain the policy until death," he said.
Look at other strategies
There may be other options, experts said, so press your agent or the company directly and ask for alternative solutions. If you need to free up a limited amount of cash or cut expenses, for example, using dividends from a whole-life policy to pay the premiums could free up some cash while preserving the benefits.