Life insurance is designed to provide a death benefit to your loved ones after you pass away. Certain policies can also accumulate cash value that you can tap into during your lifetime. There are different ways to cash out life insurance and various reasons you may want to do so. Before cashing in a life insurance policy, it’s important to weigh the pros and cons first. A financial advisor can help you decide on the right time to cash out your life insurance policy, or if it’s even the right decision for you.
Generally, you can cash out life insurance if you have a policy that has accumulated cash value. This can be a permanent life insurance policy or a convertible term life policy. But the idea is the same: There has to be some cash value in the policy for you to be able to withdraw it.
Term life insurance generally does not have cash value unless it’s converted to permanent insurance at some point. Examples of permanent life insurance include whole life, universal life, variable universal life and indexed universal life. With universal life insurance policies, the cash value that accumulates as you pay in premiums can also grow by earning interest.
The amount of cash value that accumulates can depend on the type of policy involved, how long you have the policy and how much you’ve paid in for premiums. The underlying investments can also make a difference in how much interest you earn. It’s typically for the cash value to be less than what you’ve paid in for premiums unless you’ve had the policy for several decades already.
The fees for cashing out life insurance can be pretty high but may not exist at all in your policy. This is because there are no fees for cashing out your life insurance policy other than a potential surrender fee. Many policies won’t require this fee so it’s important to know what your policy says before cashing in. A surrender fee can cost 10% – 40% of the value of cash you would otherwise receive, so make sure this is calculated and determined by reading your policy contract.
Cashing life insurance simply involves withdrawing some or all of the cash value that’s accumulated. There are different ways you can do this, depending on whether you want to keep the policy or not. The main options include:
Surrendering a life insurance policy means that you cancel the policy and in return, receive its surrender value. This is equivalent to the cash value that’s accumulated, less any fees you might owe for surrender charges. The policy ceases to exist at this point, meaning that your named beneficiary or beneficiaries wouldn’t receive any death benefits from it once you pass away. Keep in mind that if you receive more in cash value than you paid in premiums, you may owe capital gains tax on the difference.
A life settlement is an alternative to surrendering your policy. In this arrangement, you sell the policy to a third party. You remain covered under the policy and the new policy owner collects the death benefit when you die. In the meantime, you can get cash for the policy and you’re no longer responsible for paying the premiums.
If you’d like to keep your policy in place, you may be able to take out a loan against your cash value instead. The upside of this option is that it can be easier to borrow from life insurance than it might be to get a personal loan or line of credit somewhere else. The loan must be repaid with interest, though your life insurance company might offer some flexibility with repayment. If you don’t pay the loan back, that amount is deducted from the death benefit paid to your beneficiaries when you pass away.
Withdrawing cash is another possibility if you’d like to keep your policy. You’re just taking money straight out of cash value, not borrowing it, so there’s nothing to repay. But again, this reduces the death benefit available to your loved ones. Your insurance company may or may not assess a partial surrender charge for this option.
If your policy includes an accelerated death benefit rider or provision for living benefits, you could use that route for withdrawing money. This is something you might consider if you have a terminal illness and need money to pay for medical expenses or day-to-day living expenses. Anything you take out would reduce the final death benefit paid to your loved ones.
Finally, you could use your cash value to pay the premiums for the policy if you’d like to avoid doing so out-of-pocket. How long you’re able to do so depends on how much cash value you’ve built up and what you normally pay for premiums.
Whether it makes sense to cash out life insurance can depend on your financial situation and what you may need the money for. If you have other life insurance policies, for example, then cashing out one of them may not leave a sizable hole in your coverage. Or if you’re interested in switching to a cheaper policy, you may want to cash out your existing coverage in order to get back some of what you’ve paid in premiums.
Taking a loan or withdrawing cash could make sense if you need money and you’d rather not take out traditional loans or lines of credit. The key thing to consider is how that will affect the death benefit of the policy. If your loved ones would be dependent on the death benefit to pay final expenses, cover outstanding debts or just pay for everyday living expenses then shrinking the policy’s value may not make sense.
Before cashing out life insurance, ask yourself:
You could be required to pay taxes on the amount you’re cashing out of the policy, depending on how much you receive. If you receive an amount greater than the amount of premium you’ve paid into the policy then you’ll be required to pay taxes on the additional amount. Additionally, if you withdraw a dividend from the policy then it will likely be taxed as ordinary income.
Talking to an insurance agent or your financial advisor can help you weigh the pros and cons of each option for cashing out life insurance. They can also review your financial situation to help you determine how much life insurance you need and what type of policy might be best.
There’s more than one way to cash out life insurance and it’s important to understand what each one involves before making a change to your coverage. Also, consider other possibilities for raising the cash you need that wouldn’t affect your coverage. A personal loan, home equity loan or even a 401k loan may be worth weighing when you need funds on short notice.
Photo credit: ©iStock.com/courtneyk, ©iStock.com/Pineapple Studio, ©iStock.com/PeopleImages
Rebecca Lake, CEPF®Rebecca Lake is a retirement, investing and estate planning expert who has been writing about personal finance for a decade. Her expertise in the finance niche also extends to home buying, credit cards, banking and small business. She's worked directly with several major financial and insurance brands, including Citibank, Discover and AIG and her writing has appeared online at U.S. News and World Report, CreditCards.com and Investopedia. Rebecca is a graduate of the University of South Carolina and she also attended Charleston Southern University as a graduate student. Originally from central Virginia, she now lives on the North Carolina coast along with her two children. Rebecca also holds the Certified Educator in Personal Finance (CEPF®) designation.
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