A life insurance policy's primary
purpose is to make sure loved ones are financially taken care of if
you pass away. If you no longer need a particular life policy for
this reason, though, you can cash it out for a life settlement and
use that settlement to create a solid financial foundation. Follow
these steps, and a settlement will help you advance and solidify your
financial position.
Step 1: Set Aside Funds for Taxes
First, set aside some of the life
settlement to pay taxes that will be due when you file this year's
tax return. A certified public accountant can help you determine
exactly how much you need to reserve for taxes, but it's usually a
relatively small portion of your settlement because of how
settlements are taxed. They're taxed according to a three-tier
system:
- The tax basis, which is how much
you paid in premiums, is untaxed.
- The amount from your tax basis to
the policy's cash surrender value is taxed at your normal income tax
rate.
- The remainder above the cash
surrender value is taxed at capital gains rates.
For 2020, federal income tax rates
range from 10
percent to 37 percent. Capital gains tax rates range from 0 to 20
percent. The specific rates you'll be taxed at depend on your income
for the year.
By designating money to pay taxes with
before you spend any of your settlement, you'll avoid potential
financial trouble at year's end. Sometimes, people who receive a
large windfall of money spend it and then, don't have enough to cover
the taxes that they owe. You want to make sure you can pay your taxes
in full so that you don't have to take out a loan when you file.
Step 2: Create an Emergency Fund
Second, divert some of the remaining
funds into a bank account to create an emergency fund if you don't
already have one.
This bank account should be separate
from the checking account that you use for regular expenses, because
you don't want to accidentally dip into your emergency fund without
knowing. Having separate accounts keeps your regular monthly funds
and your emergency funds distinct.
Most financial experts recommend that
you maintain an emergency fund that's equal to several months of your
living expenses. This includes the essential items that you pay every
month, such as housing, food, health insurance, utilities, and
transportation costs. It doesn't include discretionary spending, like
entertainment and vacations, or saving for future financial goals.
If you already have an emergency fund
that's sufficient, you can skip this step and move onto the
following.
Step 3: Eliminate High-Interest Debt
Third, use the funds that remain from
your settlement to pay off any high-interest debt that you have. You
can use 7.5 percent as a marker of what debt falls into the
high-interest category. Anything with an annual percentage yield of 7.5
percent or more
is high and should be prioritized.
The reason to pay off high-interest
debt is twofold. First, you'll save a lot in interest once you don't
owe the debts anymore. Second, you'll also improve your cash flow
when you no longer need to make these loan payments.
Step 4: Invest in a Home
Finally, put anything that remains from
your life settlement toward homeownership. The funds can help you
save up for a down payment if you rent right now, or you can put them
toward your mortgage if you already own a home.
Homeownership is preferable to renting
if you'll be in an area for an extended amount of time, and you'll
save a lot on interest if you can put some extra money toward your
mortgage.
If you want to sell a life insurance
policy for a life settlement, contact Habersham
Funding, LLC.
