Can I Cash In a Life Insurance Policy?

Life insurance policies offer more than just a death benefit. Certain types include a “cash value” component that accumulates over time and can be accessed by the policyholder during their lifetime. Understanding how this cash value works and the conditions for access is important for policyholders.

Understanding Cash Value in Life Insurance

Cash value is a savings component within certain life insurance policies. A portion of each premium contributes to this cash value, which grows on a tax-deferred basis over the policy’s life.

The accumulation of cash value is primarily associated with permanent life insurance policies. These include whole life, universal life, and variable universal life insurance.

Term life insurance policies do not build cash value. They provide coverage for a specific period and focus solely on the death benefit, making them generally more affordable.

For permanent policies, cash value growth varies by type. Whole life policies often guarantee a fixed growth rate. Universal life policies may have growth tied to interest rates, while variable universal life policies link cash value to investment sub-accounts, offering potential for higher returns but also greater risk.

The cash value component is distinct from the death benefit, which is the payout to beneficiaries upon the insured’s passing. While the death benefit is the primary purpose of life insurance, the cash value can serve as a living benefit, providing financial flexibility during the policyholder’s lifetime.

Methods for Accessing Your Policy’s Cash Value

Policyholders have several ways to access the accumulated cash value within their permanent life insurance policies. Each method has different implications for the policy’s coverage and future value.

One method is a policy surrender, which involves canceling the insurance policy entirely. When a policy is surrendered, the policyholder receives the cash surrender value, which is the accumulated cash value minus any applicable surrender charges and outstanding loans. This action terminates the life insurance coverage, meaning the death benefit will no longer be available to beneficiaries.

Another option is a policy loan. This allows borrowing directly from the insurer, using the policy’s cash value as collateral. Loans accrue interest, often 5% to 8%, but repayment schedules are flexible, and the loan does not terminate the policy. Any outstanding loan balance, plus accrued interest, will reduce the death benefit paid to beneficiaries if not repaid.

Policyholders can also make withdrawals, or partial surrenders, from the cash value. Unlike loans, withdrawals permanently reduce the policy’s cash value and the death benefit amount.

Financial Considerations When Accessing Cash Value

Accessing a life insurance policy’s cash value involves several financial considerations, particularly regarding taxes and potential fees. These factors can significantly impact the net amount received and the policy’s ongoing benefits.

When surrendering a policy, the amount received exceeding the “cost basis” is subject to income tax. The cost basis represents the total premiums paid into the policy. For example, if premiums paid total $20,000 and the cash surrender value is $30,000, the $10,000 gain would be taxed as ordinary income.

Policy loans are not considered taxable income, as they are viewed as borrowing against an asset. However, if a policy lapses or is surrendered with an outstanding loan, the loan amount exceeding the cost basis may become taxable. This can create an unexpected tax liability.

Withdrawals from a policy’s cash value are tax-free up to the cost basis. Any amount withdrawn exceeding the premiums paid into the policy is considered taxable income. This “first-in, first-out” tax treatment means the return of principal is received before any taxable gains.

Surrender charges are fees that insurance companies may impose if a policy is terminated or funds are withdrawn during the initial years of the policy. These charges are often highest in the early years, sometimes starting around 10% to 35% of the cash value, and gradually decrease over a period that can range from 10 to 15 years. These fees reduce the amount of cash value received upon surrender.

It is also important to remember that accessing cash value through loans or withdrawals will reduce the policy’s death benefit. This means that the amount paid to beneficiaries upon the insured’s death will be less than the original face amount of the policy. Policyholders should weigh their current financial needs against the long-term protection provided by the death benefit.

Initiating a Cash Value Access Request

After evaluating access methods and financial implications, policyholders can initiate a request. The process involves direct communication with the life insurance company to formalize the transaction.

The first step is to contact the insurance provider. This can be done through their customer service line, an online portal, or by speaking with a financial advisor. The insurer will provide guidance on available options and necessary procedures.

The insurance company will require certain forms and documentation to process the request. These forms are specific to the type of access desired, whether it is a full policy surrender, a policy loan, or a partial withdrawal. The forms will gather administrative details necessary to complete the transaction.

Once the required forms are completed, they must be submitted to the insurance company. Submission methods often include mailing the physical documents, submitting them through a secure online portal, or, in some cases, delivering them in person.

After submission, policyholders can expect a processing period. This timeframe varies depending on the request’s complexity and the insurer’s internal procedures, ranging from a few business days to several weeks. Upon successful processing, funds will be disbursed according to the policyholder’s instructions, such as direct deposit or a mailed check.