If a client has a cash value life insurance policy, they probably feel pretty secure.
Even if they run into financial trouble, they can always borrow against the plan’s value, and they can usually get a pretty sweet interest rate, to boot. Insurance companies don’t mind making such loans as they know the collateral is good. It’s a good recipe for restful nights. Isn’t it?
The troubles start with a scenario where the insured party must surrender the policy as a result of foreclosure on the loan. In such cases, the tax-free nature of the insurance policy’s benefits go up in smoke. Even though the original insured party receives no apparent direct benefit from surrendering the policy, the tax authorities see it differently.
To the IRS, you’ve gained substantially by surrendering the policy – that’s how you paid off your loan. That’s a financial gain in their view and fully taxable as such. The only way to enjoy the tax-free benefits of a life policy is for the holder to keep it paid up until it pays out. Otherwise, there may be trouble.
A number of rescue strategies exist to keep an insurance policy paid up until the death benefit is activated – the only way to maintain the policy’s tax advantages. In many cases, though, this turns into a trap. The interest is often so high that it can’t be paid off, leaving the policy holder with no alternatives other than to surrender it or sell the death benefit.
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What is to be done? There are ways to salvage the situation, which involve a combination of steps to restructure the policy. A skilled insurance agent can find ways to rescue their client, but the best policy is to help your customers prevent it from happening in the first place.
For more information, please read:
Strategies To Rescue A Life Insurance Policy With A Sizable Loan | Kitces