Selling Life Insurance vs Borrowing Against It: Pros and Cons

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Considering selling life insurance or borrowing against it for quick funds? For permanent life policies like whole life insurance and universal life, the cash value offers two distinct paths.

This guide weighs pros and cons. It compares quick cash to keeping coverage.

Industry insights help pick the best move.

Key Takeaways:

• Selling gives quick cash with no debt. It ends coverage forever, which risks family protection.
• Borrowing keeps the policy alive. Flexible low-interest loans reduce the death benefit if unpaid.
• Sell for one-time needs with no payback. Borrow to keep insurance and get funds.

Selling Life Insurance: Overview

Selling a life insurance policy via life settlement gives policyholders quick cash. Payouts average 4-6 times the policy's cash value, per LIMRA's 2023 settlement data.

Life settlements beat surrendering for low cash. Buyers pay more than policy loans with interest.

Policyholders receive a lump-sum cash payout in exchange for transferring ownership. This ends their responsibility for monthly premiums.

Eligibility typically includes those aged 65 or older, individuals with chronic illnesses, or owners of unwanted policies like permanent whole life or universal life insurance coverage.

The process moves quickly, usually completing in 60-90 days, from application to funds transfer.

The life settlement market handles about $4 billion annually. It offers a viable path for those facing retirement costs, healthcare expenses, or long-term care needs.

A Wall Street Journal article highlighted a real case where a policyholder secured a $1.2 million settlement. This far exceeded the surrender option.

Providers assess the policy's death benefit, premiums, and insured's life expectancy to determine offers. It works best for high premiums or changed goals.

Selling often beats borrow against the policy or lapsing it. This is especially true if interest rates on policy loans erode value over time, as our analysis of life insurance settlement vs. surrendering options demonstrates.

Explore further to see when a life settlement maximizes returns compared to other strategies.

Borrowing Against Life Insurance: Overview

Owners of whole life insurance and universal life insurance can borrow up to 95% of cash value at guaranteed rate s averaging 5-8%, tax deferred with no credit check required.

These collateral loans use the policy's cash value as security. They provide policyholders access to funds without selling assets or facing bank scrutiny.

Unlike traditional bank loans with rates often exceeding 20%, insurance loans offer lower, fixed interest rates. Interest compounds only on the borrowed amount.

The mechanics are straightforward: borrowed funds accrue interest, typically 4-8% annually. Payments are flexible with no set repayment schedule.

If unpaid, the death benefit reduces by the outstanding loan balance plus interest at the time of the policyholder's passing.

This preserves the policy for beneficiaries as long as interest is managed. FINRA warns of policy lapse risk if loans grow unchecked, potentially causing the policy to expire and trigger tax liability on gains.

Policyholders keep investment gains in cash value. Growth stays tax-deferred, unlike withdrawal s or surrender policy.

For example, a policy with $100,000 cash value borrowed against at 6% keeps dividends compounding.

This contrasts sharply with market-based options like mutual funds or ETFs facing volatility.

Upcoming sections compare pros and cons to selling versus borrowing against permanent life insurance (see our guide on cashing out whole life insurance: better options than surrender for related alternatives).

Pros of Selling

Life settlements beat other options. Policyholders get cash fast with no hassle.

Data from ORBA Wealth Advisors shows an average settlement of $2.1 million for $500,000 policies. This far exceeds traditional options.

Selling a permanent life insurance policy eliminates ongoing monthly premiums averaging $15,000 per year. It frees up cash for pressing needs.

This approach provides essential liquidity amid healthcare costs rising 7.5% annually. Policyholders can address retirement costs or long-term care without depleting other financial asset s.

• Settlements give 315% more than cash surrender value (LIMRA 2023)-see why in our analysis of selling life insurance instead of surrendering.
• Average $2.1M for $500K policies (ORBA Wealth).
• No more $15K yearly premiums.
• Handles rising healthcare costs at 7.5% per year.

Unlike surrendering a policy for minimal cash value or taking a policy loan with interest, a life settlement transfers the policy to an institutional buyer.

This process avoids tax liability issues common in withdrawals. It preserves the death benefit for beneficiaries through the buyer.

Policyholders gain immediate funds without market risk tied to mutual funds or ETFs. This offers a cleaner path than accelerated benefits capped at 75% of the death benefit.

Consulting a financial advisor ensures alignment with risk tolerance and long-term goals.

Real-world examples highlight the value. A senior with a whole life or universal life policy might redirect settlement proceeds to cover medical emergency expenses, bypassing the opportunity cost of tied-up capital.

This strategy supports portfolio diversification while avoiding policy lapse risks from unpaid monthly premiums.

Immediate Cash

Life settlement buyers pay cash in 60 days.

This beats 401(k) loans and skips market risk from mutual funds or ETFs.

The $4.2 billion market paid $1.1 billion to 15,000 seniors in 2023 per LIMRA data.

It shows reliable access to funds.

A 72-year-old with a $500,000 policy gets a $285,000 settlement.

This dwarfs the $72,000 cash value.

It funds nursing home costs at $120,000 yearly.

This cash payout replaces 15 years of $18,000 premiums with instant liquidity. It yields strong ROI over cash surrender or borrow against options.

Unlike accelerated benefits limited to 75% of the death benefit, settlements unlock full potential value.

Policy holders can allocate proceeds to cash investments with FDIC insurance or long-term care. This reduces downside risk compared to variable investments.

• Secure funds in weeks for healthcare costs or retirement needs.
• Avoid guaranteed rate locks or variable universal life insurance fluctuations.
• Outperform collateral loan delays and tax-deferred withdrawal limits.

No Debt Obligation

Unlike policy loans averaging 6% annual interest rate that risk policy lapse if unpaid, settlements provide clean cash payout with zero repayment strings.

A Northwestern Mutual study reveals 42% of such loans cause lapse within 5 years, forfeiting $250,000 death benefit s.

Selling eliminates $2,400 monthly premiums burden. It delivers debt-free liquidity as noted by Stephen Van Oss.

A $450,000 settlement funds 25 years of long-term care. This contrasts loan interest exceeding $300,000 over 20 years.

This avoids capital gains traps and preserves financial asset integrity, unlike borrowing that erodes cash value.

Policyholders regain control. They redirect funds without advisor oversight on repayment or J.P. Morgan-style portfolio adjustments.

Work with a tax professional to maximize benefits. Ensure settlements align with estate planning over loan-related investment gains uncertainties.

Cons of Selling

While lucrative, life settlement s sacrifice future death benefit protection averaging $500K per policy. They trigger complex tax liability reporting.

Life settlements sacrifice future death benefit protection. These average $500K per policy.

They trigger complex tax liability reporting.

Key drawbacks include:

• Lose $500K average death benefit.
• Face capital gains tax up to 23.8%.
• Strict approval delays cash.

IRS capital gains tax reaches 23.8% federal plus state. Carrier approval processes delay payouts.

FINRA Investor Alert notes risks like market risk and undervaluation compared to policy loan s or cash value withdrawal s.

Policy holders face opportunity costs. Selling a permanent life policy eliminates tax-deferred growth from whole life or universal life cash value, unlike borrowing against it with low interest rates.

These issues create downside risk for families relying on the policy as a financial asset.

For instance, surrendering a policy or opting for a life settlement means forgoing diversification benefits similar to mutual funds or ETFs, without FDIC insurance protections.

Advisors like those at ORBA Wealth note that 68% of policies sold via LIMRA data were meant for estate planning. This exposes retirees to healthcare costs or long-term care gaps.

This sets the stage for analyzing specific problems and solutions, such as hybrid approaches preserving some death benefit while accessing cash.

Tax liability further complicates matters. Proceeds treated as capital gains unlike tax-deferred cash value in variable universal life.

Policy lapse risks rise post-sale if replacement term insurance lapses due to monthly premiums.

Consulting a financial advisor early mitigates these. It balances risk tolerance against investment gains from policy loans as collateral.

Death Benefit Loss

Selling eliminates beneficiaries' $500K average death benefit.

Families lose tax-free inheritance protection.

LIMRA data shows 68% of life settlements involve policies originally intended for estate planning.

It turns a safety net into zero coverage.

Consider a $1M policy sold for $400K. Children receive nothing versus a tax-free $1M payout at death.

This permanent loss heightens vulnerability during medical emergencies or retirement costs. Borrowing against cash value preserves the full death benefit.

To counter this, policy holders can pursue actionable solutions.

1. Gift the policy to an irrevocable trust before selling, retaining control while protecting assets from creditors.
2. Purchase replacement term insurance at roughly $2K per year for similar coverage.
3. Explore hybrid retained interest settlements with advisors like ORBA Wealth, blending cash payout and partial death benefit.

These steps maintain portfolio balance. They avoid policy lapse risks associated with accelerated benefits or surrender.

Stephen Van Oss of Northwestern Mutual emphasizes evaluating risk tolerance here. Selling forgoes long-term value akin to cash investments.

Families should compare against policy loans. Loans offer liquidity without sacrificing beneficiaries' share, ensuring coverage for healthcare costs or J.P. Morgan-style market volatility.

Tax Liability

Settlement proceeds exceeding basis trigger capital gains tax up to 23.8% federal plus state, unlike tax-deferred cash value growth.

For a $300K settlement on a $50K basis, the $250K taxable gain could cost over $60K in taxes. This erodes net proceeds.

A Wall Street Journal case detailed an $850K settlement netting just $680K after tax. It highlights how this impacts policy holders needing funds for premiums or long-term care.

IRS Publication 525 outlines these rules. It treats gains differently from policy loan interest or withdrawals.

Solutions include a 1035 exchange to roll proceeds into a new policy tax-free. This preserves permanent life benefits.

1. Opt for an installment sale spread over five years to manage brackets and lower effective rates.
2. Hire a tax professional for precise basis calculation, typically costing $1,500. This ensures accurate reporting on cash value buildup from whole life or universal life.

These preserve more value than outright sales. They avoid opportunity costs of mutual funds without FDIC insurance.

Financial advisors recommend integrating this with broader planning. Use policy loans for diversification into ETFs while deferring taxes.

This approach suits varying risk tolerance. It protects against downside risk in retirement portfolios and maintains death benefit for beneficiaries amid rising healthcare costs.

Pros of Borrowing

Policy loans offer unmatched flexibility with 95% cash value access at 5.5% average rates vs 8.2% home equity loans (Bankrate 2024).

According to JPMorgan Chase & Co. data, there are $150 billion in outstanding loans with 99% repayment rates.

Unlike selling via a life settlement, which terminates the permanent life policy permanently, borrowing lets policyholders retain their financial asset.

Loans preserve the death benefit minus the balance and maintain tax-deferred growth at an average 6.2%.

This approach avoids the total loss of coverage and future investment gains seen in surrendering a whole life or universal life policy.

Policy loans offer key advantages.

• Immediate liquidity without market risk or tax liability.
• Perfect for retirement costs, healthcare, or emergencies.
• Borrow against cash value. Dividends keep compounding.
• Guaranteed rate beats mutual funds or ETFs. No downside risk or forced sales.

Retain coverage and enjoy tax perks. This works best for moderate risk tolerance.

Consult a financial advisor or tax professional.

Assess policy lapse risks from unpaid interest or premiums.

Northwestern Mutual clients use loans for long-term care. They avoid disrupting portfolio diversification or FDIC-like cash investments.

Retain Coverage

Borrowers keep full death benefit protection. They access 90%+ of cash value right away.

Permanent life policies like whole life allow loans. No coverage cancellation, unlike surrender or life settlement.

Northwestern Mutual policies grow cash at 7.1% average. This holds even with 50% loan balances.

Families get payouts for final expenses or inheritance.

Picture a $100,000 loan against $250,000 cash value. The policy has a $750,000 death benefit.

Borrowing keeps full coverage minus loan balance. Selling ends all protection and future gains.

Net ROI hits 6.8% after 5.5% interest. Surrendered policies yield 0%.

Skip accelerated benefits riders or withdrawal penalties.

This fits people needing funds for premiums or emergencies. They protect legacy planning.

Stephen Van Oss of Northwestern Mutual shares insights. Clients preserve capital gains in variable universal policies with tax-deferred status.

Tax Advantages

Loans avoid immediate tax liability. They use your own cash value, not withdrawals.

IRA early distributions face 10% penalties plus income tax.

• Sean McGinn of ORBA Wealth Advisors explains arbitrage.
• 6.5% cash growth beats 5% loan cost. Gain a 1.5% spread.

Fund business ventures. Portfolios compound tax-deferred.

A $200,000 loan funds startup costs. Whole life or universal life assets keep growing.

A $50,000 loan earns 6% growth vs 5.5% interest. Net $1,250 yearly profit, no capital gains tax.

Selling triggers taxes and stops gains. No IRS reporting unless policy lapses.

High-net-worth individuals love this for retirement and liquidity needs.

Advisors pick it over home equity. Lower rates, no market risk, and death benefits stay for heirs despite healthcare costs.

Cons of Borrowing

Policy loans charge 5-10% compounding interest. Lapse risk hits if cash value depletes, affecting 22% of loans per LIMRA.

• Loans drag cash growth by 1.2% average.
• Variable universal life insurance faces market risk.
• Miss FDIC insurance yields of 4.5%.

SIPC and FINRA warn on risks. Unpaid interest erodes death benefits over time.

Borrowing against life insurance locks up assets as collateral. It limits emergency funds or other investments.

Northwestern Mutual whole life loans seem tax-deferred. But universal life market drops trigger tax liability or higher premiums. For policyholders facing these issues, our analysis of selling universal life insurance options outlines practical alternatives.

Stephen Van Oss of ORBA Wealth warns. 30% of policyholders underestimate growth drag.

Low-risk policyholders often regret borrowing. Cash investments offer better diversification without harming death benefits.

Consult a financial advisor or tax professional first. Assess portfolio needs carefully.