Can I Cash In a Term Life Insurance Policy?

Term life insurance is a common choice for financial protection. A frequent question is whether these policies can be “cashed in” like other financial products. Term life insurance policies do not accumulate a cash value that policyholders can access during the policy’s term. They are designed to provide a death benefit for a specific period, distinct from permanent life insurance options that include a savings component.

Understanding Term Life Insurance and Cash Value

Term life insurance provides coverage for a specific duration, such as 10, 20, or 30 years. Its primary function is to pay a death benefit to beneficiaries if the insured passes away within the specified term. This type of insurance is often called “pure protection” because premiums cover the cost of insurance without building an investment or savings component. Premiums for term policies are typically lower than those for permanent policies, reflecting their temporary nature.

Cash value refers to a savings or investment portion within a policy that grows over time. It accrues from premium payments and often grows on a tax-deferred basis. Policyholders can access this accumulated cash value through withdrawals or loans. Permanent life insurance policies, such as whole life or universal life, are designed to build cash value, offering a living benefit. Term life policies, however, focus solely on providing a death benefit for a limited period and do not include this investment component.

Exploring Policy Conversion Options

Many term life insurance policies include a “convertibility” feature. This option allows policyholders to convert their term policy into a permanent life insurance policy, such as whole life or universal life, without needing a new medical examination. This conversion can be a valuable option if an individual’s financial situation or need for lifelong coverage changes. For instance, someone might choose to convert to build cash value, ensure lifelong coverage, or if their health has changed, making it difficult to qualify for a new permanent policy.

The conversion process involves contacting the insurance provider to understand available permanent policy types and their costs. Policyholders complete conversion paperwork, specifying the coverage amount. While there is no direct fee for conversion, the new permanent policy will have significantly higher premiums. This increase reflects lifelong coverage and the cash value component that accrues after conversion. Cash value growth within the new permanent policy is tax-deferred, meaning taxes are not owed on the increase in value as long as the policy remains active. Taking loans or withdrawals from the cash value may have tax implications, especially if the policy becomes a Modified Endowment Contract (MEC) or if withdrawals exceed premiums paid.

Selling a Term Life Insurance Policy

Policyholders can receive funds from a term life insurance policy, even without cash value, through a life settlement. This involves selling an existing policy to a third party for a lump sum. The payout is typically more than any cash surrender value (if applicable) but less than the policy’s full death benefit. The third-party buyer assumes responsibility for future premium payments and receives the death benefit when the insured passes away.

A viatical settlement is a specific type of life settlement for policyholders who are terminally or chronically ill. For a general life settlement, eligibility often includes being over 65 or having a significant health impairment, with the policy needing a death benefit of at least $100,000. For viatical settlements, a terminal illness diagnosis (life expectancy of 24 months or less) is a requirement. The policy typically needs to have been in force for at least two years. The process generally involves an appraisal, working with a broker to solicit offers, and then transferring ownership.

Proceeds from a life settlement are generally taxable. The amount received up to cumulative premiums paid is not taxed. Any proceeds exceeding premiums paid, up to the policy’s cash surrender value, are taxed as ordinary income, and amounts above the cash surrender value are taxed as long-term capital gains. However, viatical settlements for terminally ill individuals are not considered taxable income.

Cancelling a Term Life Insurance Policy

When a term life insurance policy is cancelled or lapses due to non-payment, the policyholder does not receive any payout or refund. Coverage ends, and the insurer’s obligation to pay a death benefit ceases. This is a direct consequence of term life insurance’s lack of a cash value component.

In contrast, permanent life insurance policies, which build cash value, may provide a cash surrender value upon cancellation. However, even with permanent policies, surrender charges can reduce the amount received, especially if cancelled in early years. For term life policies, premiums cover the cost of insurance for the coverage period. Once terminated, there is no return of premiums unless within a “free look” period (typically 10 to 30 days) or if premiums were paid in advance.