Many people purchase life insurance with the goal of providing financial protection for their loved ones after they pass away. However, certain types of life insurance policies allow policyholders to access their funds while still alive. Whether you need to cover medical bills, supplement your retirement income, or handle unexpected expenses, cashing out your life insurance may offer a financial lifeline.
This guide explores how to cash out life insurance while alive, including various methods, policy types, and the implications of each decision. Understanding your options can help you make the best financial choices for your current needs and long-term goals.
Key Takeaways
- You can cash out life insurance through policy loans, withdrawals, surrendering the policy, accessing living benefits, or selling the policy through a life settlement.
- The amount you receive depends on your policy’s cash value, how long it has been active, and the method you choose to access the funds.
- Only permanent life insurance policies like whole life, universal life, and indexed universal life have cash value components that can be cashed out. Term life insurance does not offer this option.
Understanding Cash Value in Life Insurance
Not all life insurance policies come with a cash-out option. To understand how to access your policy’s value, it’s important to first understand what “cash value” means and how it works in the context of permanent life insurance.
What is “Cash Value?”
Cash value is a feature included in most permanent life insurance policies. It serves as a built-in savings account that accumulates over time as you pay your premiums. A portion of each premium goes toward the policy’s death benefit, while another portion contributes to the policy’s cash value.
The way the cash value grows depends on the type of policy. In whole life insurance, it grows at a fixed rate. Indexed universal life insurance grows based on a market index, like the S&P 500, although the growth is typically capped and floored to manage risk.
The cash value is a liquid asset, meaning you can tap into it while you are still alive. You can use it to take out policy loans, make withdrawals, or even use it as collateral for outside financing.
Types of Life Insurance with Cash Value
The cash value feature is specific to permanent life insurance policies. Here are the main types that allow cashing out:
- Whole life insurance offers predictable, guaranteed cash value growth and fixed premiums.
- Universal life insurance gives more flexibility, allowing you to adjust premiums and death benefits as your financial situation changes.
- Indexed universal life insurance ties the cash value to market indexes, offering potential for higher growth but with more variability.
On the other hand, term life insurance does not have a cash value component. These policies are designed only to provide a death benefit for a specific period, such as 10, 20, or 30 years. If you’re looking to cash out life insurance, you’ll need a policy that accumulates cash value.
To explore other financial options for your policy, consider reading more about viatical settlements and life settlements.
Options for Cashing Out Life Insurance
If you have a permanent life insurance policy, you have several ways to access its value. Each option has unique benefits and potential drawbacks. Understanding them will help you choose the best route based on your financial goals and policy structure.
Policy Loans
One common method is to take a loan against your policy’s cash value. These loans usually come with low interest rates and do not require credit checks, making them an attractive option for those in need of quick funds.
The key advantage of a policy loan is that it does not reduce your death benefit unless the loan is not repaid. If you pass away with an outstanding loan, the unpaid balance is deducted from the death benefit paid to your beneficiaries.
Keep in mind that interest will continue to accrue on the borrowed amount. If left unpaid, the interest could grow large enough to exceed the remaining cash value, potentially causing the policy to lapse.
Withdrawals
Another option is to make a direct withdrawal from the policy’s cash value. This method provides immediate access to funds and does not require repayment.
Withdrawals are generally tax-free up to the amount you’ve paid in premiums. For example, if you’ve paid $30,000 in premiums over the years and withdraw $25,000, you typically won’t owe any taxes. However, if you withdraw more than your total premium payments, the excess is considered taxable income.
Unlike loans, withdrawals permanently reduce the death benefit. This means your beneficiaries will receive a lower payout when you pass away.
Surrendering the Policy
If you no longer need life insurance coverage, you might consider surrendering the policy entirely. When you surrender a policy, the insurance company cancels it and pays you the cash surrender value, which is the cash value minus any surrender charges or fees.
This option provides a full payout of available funds, but it also ends the life insurance coverage. If you later decide you need insurance again, it may be more expensive or difficult to qualify due to age or health conditions.
Surrender charges often apply during the early years of the policy and can significantly reduce the amount you receive. It is important to review your policy’s terms or speak with your provider to understand how surrender fees could affect your payout.
Using Living Benefits
Some policies offer living benefits for those diagnosed with a terminal illness. These provisions allow you to access a portion of your death benefit while still alive to help cover medical bills or other expenses.
Living benefits can provide critical financial support during a challenging time. However, the funds you access now will be subtracted from the death benefit your beneficiaries receive later.
Eligibility typically requires documentation of a terminal diagnosis with a life expectancy of 12 to 24 months, depending on the insurer. You’ll also need to submit a claim and await approval before receiving funds.
Additional Considerations When Cashing Out
Cashing out life insurance is not just a financial transaction. It can have ripple effects on your tax situation, estate planning, and financial legacy. Be sure to weigh these considerations before making a decision.
Tax Implications
The cash value in a life insurance policy grows tax-deferred, meaning you don’t owe taxes on the growth until you withdraw or otherwise access it.
Withdrawals are generally tax-free up to the total amount of premiums you’ve paid. But if you withdraw more than that, the excess is taxed as income. For example, if your cash value has grown to $80,000 and you’ve paid $50,000 in premiums, only the $30,000 in growth would be taxable.
Surrendering the policy or taking out large loans can also trigger taxable events. If you surrender a policy for more than you’ve paid into it, the difference may be taxed.
Learn more about the tax consequences by reading our guide to taxes on life settlements.
Impact on Beneficiaries
Any method of cashing out your policy will likely reduce the death benefit your beneficiaries receive. Withdrawals and loans lower the available funds, while surrendering the policy eliminates the death benefit entirely.
Before accessing your policy’s cash value, consider the long-term impact on your loved ones. Will they still have enough financial support in your absence? Are there other resources you can draw from instead?
Balancing your current financial needs with your legacy goals is essential. If preserving the death benefit is important, alternatives like small loans or partial withdrawals may be more suitable than surrendering the policy altogether.
Advanced Strategies for Maximizing Cash Value
Beyond simple withdrawals and loans, there are more strategic ways to use your life insurance policy’s value. These methods can help you unlock additional benefits or achieve greater returns.
Policy Conversion
If you have a term life policy, you may be able to convert it to a permanent policy. This conversion allows you to start building cash value while maintaining coverage.
Many term policies include a conversion clause, which lets you switch to a permanent policy without undergoing a new medical exam. This can be valuable if your health has declined since the original policy began.
Once converted, you can begin accumulating cash value and access it later through loans or withdrawals. This strategy is useful for people whose financial goals have shifted from short-term protection to long-term planning.
Selling Your Life Insurance Policy
One of the most lucrative options is selling your policy through a life settlement or viatical settlement. This involves transferring ownership of your policy to a third party in exchange for a lump-sum payment.
In a life settlement, the buyer continues paying the premiums and collects the death benefit when you pass away. The payment you receive is usually higher than the surrender value but lower than the full death benefit.
This strategy can be especially helpful if you no longer need the coverage or cannot afford the premiums. It is also an option for policyholders with serious health conditions, who may qualify for a viatical settlement.
To explore this option, visit our life settlement page or get started here.
Conclusion
Cashing out life insurance while alive can offer vital financial support during times of need. From policy loans to full policy sales, each option comes with distinct advantages and trade-offs. It’s important to understand how these methods affect your policy, taxes, and beneficiaries.
If you have a permanent life insurance policy, you have several ways to tap into its value. Consider your immediate financial goals, long-term legacy plans, and tax situation before deciding on the best path forward.
For those interested in exploring life settlements as an alternative to surrendering their policy, Ovid can help. Learn how to sell your life insurance policy and discover whether this option can provide a better financial outcome for you and your loved ones.
