FOCUS AREA LONG-TERM INSURANCE

THE FINANCIAL EFFECTS OF EARLY WITHDRAWALS ON INSURANCE POLICIES

Consumers are cautioned to note that some insurance products are designed in such a way that a policyholder will be able to make early withdrawls from his or her insurance policy, as a benefit. A good example of such a policy is a life insurance policy that is coupled with a savings portion and a policyholder may exercise an early withdrawal option although not mandatory to make such withdrawal(s) from the policy. The withdrawals are built up from the regular policy premiums or lump sum paid by the policyholder.

Insurance policy withdrawals definition

In simple terms – Insurance policy withdrawals refer to removing cash value from an insurance policy. Making a cash withdrawal from an insurance policy entails either a partial or full withdrawal of the cash value of a policy before the policy matures or before the occurrence of an insured event. Withdrawals from an insurance policy may have negative consequences on the future benefits of a policyholder as well as their beneficiaries. In essence, a cash value withdrawal creates a loan account or debt against the insurance policy.

Therefore understanding the policy cash value is vital to making an effective and well informed decision on whether or not to withdraw cash value from an insurance policy.

Understanding cash value

Some life insurance policies have two (2) components namely the face value which is the amount that will be paid to your beneficiaries upon death and the cash value which is a savings account or component funded by a portion of the premiums paid by the policyholder or premium payer. Over time as premiums are paid, the cash value accumulates and becomes available for withdrawal. This feature of an insurance policy is commonly referred to as a savings option and it’s the option against which withdrawals can be made. The cash value is very important as it can be used to pay premiums and keep policyholders’ insurance contract in force during financial difficulties or circumstances when the policyholder or premium payer is unable to pay the premiums as contractually required. Withdrawing from the insurance policy reduces the total policy benefit by the amount of the cash withdrawal plus interest when the insurance policy reaches maturity.

Common factors for withdrawals

The cash value may be withdrawn to meet everyday expenses and lifestyle demands during stressful financial times. Another motivating factor for withdrawals could be for investment purposes that is, if one has accumulated a high cash value and is presented with an investment opportunity that generates an alternative higher return.

Disadvantages of withdrawals

Withdrawals on cash value can have the following unfavorable consequences:

• Withdrawal of cash value could cause a reduction in policy benefit such that beneficiaries might not be able to pay for final expenses, anticipated debts or ongoing living expenses. Thereby compromising long-term goals and the beneficiaries’ financial future.

• Cash value reduce withdrawals reduces the cash surrender value of a policy which could cause premiums to increase in order to maintain the same amount of policy benefit.

• Withdrawals may increases the possibility of policy lapses.

• Withdrawals may be subject to surrender charges and or processing fees.

Conclusion

Removing the cash value from an insurance policy through early withdrawals may expose policyholders as well as their beneficiaries to life’s uncertainties. Policyholders should be cautious and not be tempted to make uninformed withdrawals from their policies as withdrawals have negative consequences. Before making withdrawals from insurance policies, one should first consider why the policy was purchased, whether the coverage is still needed and whether the value of the policy that remains after the withdrawal will be sufficient to cover the needs of the policyholder and/or beneficiaries who would be dependent on the insurance benefit in the event of the policyholder’s disability, death or significant change of financial position.

“The longer I go on, the more I am aware of the power of finance.”

– Justin Welby

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