Cashing In Your Life Insurance Policy (2024)

In some situations, you may find you need cash to cover an expense, from a major one-time expense like a renovation to everyday expenses if you cash flow is tight. If you have a life insurance policy with cash value, you could cash it in to access needed funds, but there are several downsides to consider with this solution.

Using life insurance to meet immediate cash needs can potentially compromise your long-term goals or your family's financial future. However, if other options are not available, cash-value life insurance could be a source of needed income. Learn more about the pros and cons of cashing in your life insurance policy and how to do it.

Key Takeaways

  • If you must access your life insurance policy, it's better to withdraw or borrow cash, instead of surrendering the policy altogether.
  • Cash-value life insurance policies (such as whole life or universal life) include a cash accumulation account where excess premium payments and earnings are held.
  • Cash-value accounts allow policyholders to access that money through withdrawals, policy loans, or—if needed—surrendering the account, either partially or in full.
  • You will only need to pay taxes on amounts that exceed the total amount of premiums paid into the policy.
  • With a life settlement, you sell your life insurance policy to a person or life settlement company in exchange for cash.

How You Can Access Cash

Cash-value life insurance, such as whole life and universal life, builds reserves by amassing excess premiums plus earnings. These deposits are held in a cash-accumulation account within the policy.

These types of permanent insurance offer the opportunity to access accumulated cash within the policy through withdrawals, policy loans, or partial or full surrenders. You could also sell your policy for cash using an approach known as a life settlement.

Remember that although cash from the policy might be helpful during stressful financial times, you could face unwanted consequences depending on the method you use to access the funds, including higher tax liabilities and reduced payouts to beneficiaries.

How to Withdraw Cash From a Life Insurance Policy

Generally, it is possible to withdraw limited amounts of cash from a life insurance policy. The amount available differs based on the type of policy you own and the company issuing it. The main advantage of cash-value withdrawals is they are not taxable up to your policy basis, as long as your policy is not classified as a modified endowment contract (MEC). An MEC is a life insurance policy in which the funding exceeds federal tax law limits.

Cash-value withdrawals can also have unexpected or unrealized consequences such as:

  • Withdrawals that reduce your cash value could cause a reduction inyour death benefit—a potential source of funds your beneficiariesmight need for income replacement, business purposes, or wealth preservation.
  • Cash-value withdrawals are not always tax-free. If, for example, you take a withdrawal during the first 15 years of the policy—and the withdrawal causes a reduction in the policy's death benefit—some or all of the withdrawn cash could be subject to taxation.
  • Withdrawals are treated as taxable to the extent that they exceed your basis in the policy.
  • Withdrawals that reduce your cash surrender value could cause your premiums to increaseto maintain the same death benefit; otherwise, the policy could lapse.
  • If your policy has been classified as a MEC, withdrawals generally are taxed according to the rules applicable to annuities—cash disbursem*nts are considered to be made from interest first and are subject to income tax, plus possibly a10% early-withdrawal penalty if you're under 59½ at the time of the withdrawal.

Taking a Loan From Your Life Insurance

Most cash-value policies allow you to borrow money from the issuer using your cash-accumulation account as collateral. Depending on the policy terms, the loan might be subject to interest at fixed or variable rates. However, you are not obligated to qualify for the loan financially. The amount you can borrow is based on the value of the policy's cash-accumulation account and the contract's terms. Generally speaking, less value will be available during the policy's early years.

The good news is that borrowed amounts from non-MEC policies are not taxable. You also don't have to make payments on the loan, even though the outstanding loan balance might be accruing interest. You can pay off the loan on your own terms, or leave the debt to be settled when the policy terminates.

The bad news is loan balances generally reduce your policy's death benefit, meaning your beneficiaries might receive less than you intended. Also, an unpaid loan that is accruing interest reduces your cash value, which can cause the policy to lapse if insufficient premiums are paid to maintain the death benefit.

If the loan is still outstanding when the policy lapses or if you later surrender the insurance, the borrowed amount becomes taxable to the extent the cash value (without reduction for the outstanding loan balance) exceeds your basis in the contract.

Policy loans from a policy that is considered a MEC are treated as distributions, meaning the loan amount up to the policy's earnings will be taxable and could also be subject to the pre-59½ early-withdrawal penalty.

Withdrawing money or borrowing money from your life insurance policy can reduce your policy's death benefit. Surrendering the policy means you are giving up the right to the death benefit altogether.

Surrendering a Policy

In addition to withdrawals and policy loans, you can sign a lost policy release (LPR) to surrender or cancel your policy and use the cash any way you see fit. You can surrender part of the value in your policy while leaving the policy in force, or you can surrender the entire value and terminate the policy.

If you surrender the policy during the early years of ownership, when the value is relatively low, the company will likely charge surrender fees, reducing your cash value. These charges vary depending on how long you've had the policy and, often, on the amount being surrendered. Some policies can levy surrender charges for many years after the policy is issued.

In addition, when you surrender your policy for cash, the gain on the policy is subject to income tax. Additional taxes could be incurred if you have an outstanding loan balance against the policy.

Although surrendering the policy can get you the cash you need, you're relinquishing the right to the death-benefit protection afforded by the insurance. If you want to replace the lost death benefit later, getting the same coverage might be more complicated or more expensive.

If you have the means, consider other options before using your life insurance policy for cash, such as borrowing against your 401(k) planor taking out a homeequity loan. None of these options comes without mitigating issues, but based on your current financial circ*mstances, some choices may be better than others.

Life Settlement

Life settlement is fairly straightforward. As the policy owner, you sell your life insurance policy to an individual or a lifesettlement company in exchange for cash. The new owner will keep the policy in force (by paying the premiums) and reap a return on the investment by receiving the death benefit when you die.

Most types of insurance are eligible for sale, including policies with little or no cash value, such as term insurance. Generally, to qualify for a life settlement, you (the insured) must be at least 65 years old, have a life expectancy of 10 to 15 years or less, and the policy death benefit must be at least $100,000 (in most cases).

The primary advantage of a life settlement is that you will get more for the policy than by cashing it in (surrendering the policy). The taxation of life settlements is complicated. In general, any gain in excess of your basis in the policy is taxed to you as ordinary income. Be sure you get expert tax advice before signing over your policy.

Although life settlements can be a valuable source of liquidity, consider the following downsides:

  • You're giving up control of the death benefit.
  • The new policy owner(s) will have access to your past medical records and usually has the right to request updates on your current health.
  • The lifesettlement industry is marginally regulated, so there's little (if any) guidance on your policy's value. Not all states regulate the industry, and many regulations only apply to disclosures. The lack of price transparency makes it difficult to determine whether you're getting a fair price for your policy,
  • Aside from the tax liability that you could face, life settlements usually come with another cost. As much as 30% of your proceeds could be paid in commissions and fees, which reduces the net amount you receive.

Can You Cash Out a Life Insurance Policy?

You can cash out a life insurance policy. How much money you get for it will depend on the amount of cash value held in it. If you have, say $10,000 of accumulated cash value, you would be entitled to withdraw up to all of that amount (less any surrender fees). At that point, however, your policy would be terminated. Instead, you can withdraw smaller amounts or take a policy loan against a portion of that value (often up to 90%).

Do You Have to Pay Taxes When Cashing out a Life Insurance Policy?

If you withdraw up to the amount of the total premiums paid into the policy, the transaction is not taxable as it is considered a return of premiums. If, however, you then withdraw any gains on the policy (like dividends), then these amounts could be taxed as ordinary income.

Is There a Penalty for Cashing out Life Insurance?

Some policies will have a surrender fee in the case of cashing out an entire policy, while others may charge fees for partial surrenders. Other than that, there are no additional penalties or fees. The surrender fee is usually 10% to 20% but it can be as high as 35% to 40%. Check your policy contract.

How Much Will I Receive If I Surrender My Life Insurance Policy?

When you surrender your life insurance policy, you don't receive the death benefit, only the cash surrender value, which is the cash value minus any fees that are charged by your insurance company. Payments from withdraws or loans on a life insurance policy generally are made within 14 to 60 days from the time the request is received.

When Should I Cash Out my Whole Life Insurance?

While it isn't always advisable to cash out your life insurance policy, many advisors recommend waiting at least 10 to 15 years for your cash value to grow. Consider reaching out to your insurance agent or a retirement specialist before cashing in a whole life insurance policy.

The Bottom Line

You may want to liquidate assets for cash for any number of reasons. With cashing in your life insurance policy, you might have no other choice, but when it comes to life insurance, think about why you purchased the policy in the first place. Do you still need the coverage? Are the policy's beneficiaries depending on the death benefit if something happens to you? Consider the answers to these questions carefully.

Explore other options such as a home equity loan, borrowing from your retirement account, or even selling your insurance policy (if allowed). Review these alternatives before you cash in a life insurance policy that you may need.

Cashing In Your Life Insurance Policy (2024)

FAQs

What happens when I cash in my life insurance policy? ›

You'll generally receive most or all of the cash value that has accumulated in your life insurance policy, but it may be subject to surrender fees and federal income taxes. Any unpaid premiums will also be collected.

What is the cash value of a $10000 whole life insurance policy? ›

The $10,000 refers to the face value of the policy, otherwise known as the death benefit, and does not represent the cash value of life insurance policy. A $10,000 term life insurance policy has no cash value.

Is it a good idea to cash out life insurance? ›

It might not be wise to cash out a life insurance policy when you need money. You may want to consider how the decision will impact your family if you die without a policy or with a lower death payout due to this decision. Choosing an alternative way to access funds might make more sense for you now and in the future.

What are the tax consequences of cashing in a life insurance policy? ›

The earnings on the cash value of your life insurance policy usually grow tax-free or tax-deferred, but you might owe taxes if you withdraw the money. You'll generally owe taxes on money earned from investment or interest gains, known as your “above basis” amount.

How much cash is a $100 000 life insurance policy worth? ›

How much can you sell a $100,000 life insurance policy for? On average, you can expect to receive 20% of the policy's face value when you sell it, according to the Life Insurance Settlement Association (LISA). That means a $100,000 life insurance policy might sell for $20,000. However, this is only an average.

What are the pros and cons of cashing out life insurance? ›

Pros: No interest is paid on a withdrawal. Cons: A withdrawal reduces your policy cash value and death benefit. It may be taxable if the withdrawal exceeds the amount of premiums paid.

How soon can I borrow from my life insurance policy? ›

How long does it take to borrow against life insurance? It often takes five to 10 years to accumulate enough cash value to borrow against your life insurance policy. The exact length of time depends on the structure of your policy, including your premiums and rate of return.

When should you cash out a whole life insurance policy? ›

There is no perfect time to cash out your whole life insurance policy. You bought the policy to take care of your loved ones, not to save for a rainy day. However, if you have no other choice, you should wait at least 10 to 15 years so your cash value has time to increase.

Do you get money back if you cancel life insurance? ›

In most cases your premium payments will be forfeited, and you will not receive anything for your previous payments. The one exception to this is if you have whole life insurance and cancel it. You may have built up equity for all of the payments you have made so you may receive a lump sum payment from your insurer.

How much will I receive if I surrender my life insurance policy? ›

Fortunately, it's easy to calculate your cash surrender value. First, add up the total payments you've made toward your life insurance policy. Then, subtract the surrender fees your insurance company will charge. You'll be left with the actual payout you may receive if you terminate or surrender your life insurance.

What is the cash value of a $25000 life insurance policy? ›

Examples of Cash Value Life Insurance

An example is a cash value life insurance policy with a $25,000 death benefit. Assuming you don't take out a loan or withdraw, the cash value accumulates to $5,000. After the policyholder's death, the insurance company would pay out the full death benefit, which would be $25,000.

What happens to the cash value after the policy is fully paid up? ›

What happens to the cash value after the policy is fully paid up? The company plans to use the cash value to pay premiums until you die. If you take cash value out, there may not be enough to pay premiums.

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