Life insurance debt arises out of life insurance withdrawal/loan provisions. Therefore, life insurance debt is a function of permanent life insurance (also known as cash-value life insurance). The concept of life insurance debt can be viewed in two ways. Life insurance debt can be involuntarily created or created by voluntary withdrawals.
How you pay life insurance debt depends on whether you can borrow your own money interest-free or with interest. Also, repayment depends on the circumstances of the debt and the terms and conditions of borrowing or withdrawals that are stated in the policy contract.
The wonderful thing about life insurance debt is that you are borrowing from yourself. This suggests that in ‘repaying’ a loan, you need not actually have to put out more money or pay interest. There are some non-forfeiture options available on life insurance policies that can be used to ease repayment of a life insurance debt.
Reduced paid-up life insurance non-forfeiture option
Using this option, you can employ the residual cash value to eliminate the debt. Consequently, the amount of insurance cover that you have will be adjusted downwards at prevailing premium rates. The insurer will deduct the amount of the debt (including any interest) and also deduct any pertinent fees from your cash value to determine the residual cash value. This can then be used to purchase permanent life cover without any further premiums being due. Reduced paid-up insurance is a good option if you have policy debt but don’t have a great need for life cover.
Policy cancellation/ surrender
With permanent insurance, a policy loan does not necessarily have to be repaid. What happens is that the insurer would reclaim the amount of insurance. It is for this reason that insurers do not typically allow full withdrawal/ loans from the cash value of a life insurance plan. This option is handy when repaying the life insurance plan is unfavourable to your situation.
Since interest is charged on life insurance loan provisions on Whole Life plans (Universal Life plans are more flexible), it is better to pay off your life insurance debt quickly, if you want to maintain the plan as is. Instead of dragging out the payments, it is wiser to pay a lumpsum.
Sometimes life insurance debt arises out of a few missed premiums. Automatic Premium Loans are a safety net for permanent insurance plans that ensures that permanent life insurance policies remain in force. However, they can create a situation where the missed premiums and interest are charged against your cash value.
In that situation, non-forfeiture options are often the safer bet. Life insurance debt is one that you should only repay if absolutely necessary. If not, there are alternatives available that ensure that you can ‘pay’ the debt without putting out even more for much less.