Can I Cash Out a Life Insurance Policy?

Certain types of life insurance policies accumulate a “cash value” during the policyholder’s lifetime. This accumulated value can be accessed by the policyholder for various financial needs.

Life Insurance Policies with Cash Value

Cash value life insurance refers to permanent policies that build a savings component over time. Three common types that accumulate cash value are whole life, universal life, and variable universal life insurance.

Whole life insurance offers a guaranteed death benefit and a fixed premium. A portion of each premium payment contributes to the cash value, which grows at a guaranteed interest rate. This consistent growth makes whole life a predictable option.

Universal life insurance provides more flexibility than whole life, allowing adjustments to premium payments and the death benefit. The cash value in a universal life policy typically grows based on current interest rates set by the insurer or linked to an external index. A portion of the premium goes towards the cost of insurance and administrative fees, with the remainder contributing to the cash value.

Variable universal life insurance (VUL) combines a death benefit with investment subaccounts. The cash value growth is tied to the performance of chosen investments, such as stocks and bonds, offering potential for higher returns but also greater risk. Policyholders can direct their cash value into various investment options.

Understanding Your Policy’s Cash Value

Cash value in a life insurance policy represents a savings component that accumulates over time, separate from the death benefit. A portion of each premium paid into a permanent life insurance policy is allocated to this cash value account. The growth of this cash value generally occurs on a tax-deferred basis.

The cash value account grows progressively, allowing it to become a financial asset that can be used for various purposes during the policyholder’s lifetime. The rate and method of cash value accumulation depend on the specific policy type.

To determine the current cash value, a policyholder can refer to their annual policy statements or contact their insurance company directly. Consulting with a financial advisor or the insurance agent who sold the policy can also provide insights.

Methods for Accessing Policy Value

Policyholders have several methods available to access the accumulated cash value within their permanent life insurance policies: surrendering the policy, taking a policy loan, or making a partial withdrawal. Each option has distinct implications for the policy’s death benefit and its continued coverage.

Surrendering a life insurance policy involves terminating coverage in exchange for its cash surrender value. The cash surrender value is the accumulated cash value minus any applicable surrender charges or outstanding loans. Surrender charges may apply, especially if the policy is terminated in its early years; these charges typically decrease over time. When a policy is surrendered, the death benefit is eliminated, and the policyholder receives a lump sum payment.

A policy loan allows the policyholder to borrow directly against the accumulated cash value. The cash value serves as collateral, and the policy generally remains in force. Interest accrues on the loan, and any unpaid loan balance, including accrued interest, will reduce the death benefit paid to beneficiaries. Policy loans do not require a credit check and can offer competitive interest rates.

Partial withdrawals enable policyholders to take a portion of their cash value without terminating the policy. This option directly reduces the policy’s cash value and can also lead to a proportional reduction in the death benefit. Unlike a loan, a withdrawal does not accrue interest. Some policies may limit the number or amount of partial withdrawals. Using the cash value to pay future premiums can be useful during periods of financial difficulty to maintain coverage.

Tax Considerations for Accessing Policy Value

Accessing the cash value from a life insurance policy involves specific tax considerations, which vary depending on the method used. Generally, the growth of cash value within a life insurance policy is tax-deferred as long as the policy remains in force and meets specific IRS criteria under Section 7702.

When a policy is surrendered, any amount received that exceeds the total premiums paid into the policy (known as the cost basis) is taxable as ordinary income. For example, if $20,000 in premiums were paid and the cash surrender value is $30,000, the $10,000 gain would be subject to ordinary income tax rates.

Policy loans are generally considered tax-free transactions, as they are treated as borrowing against an asset. However, if the policy lapses or is surrendered with an outstanding loan, the loan amount exceeding the policy’s cost basis could become taxable income. This can sometimes lead to “phantom income.” Special rules apply if the policy is a Modified Endowment Contract (MEC) under IRS Section 7702A, where loans and withdrawals may be taxed less favorably and may incur a 10% penalty if taken before age 59½.

Partial withdrawals are generally tax-free up to the amount of premiums paid (the cost basis). Amounts withdrawn that exceed the cost basis may be subject to ordinary income tax. It is important to note that accessing cash value, whether through surrender, loan, or withdrawal, can reduce the policy’s death benefit, which could impact financial protection for beneficiaries. Consulting with a tax professional is recommended to understand the specific tax implications for individual circumstances.

Steps to Accessing Your Policy’s Cash Value

Once a policyholder has determined their policy’s cash value and decided on the most suitable access method, initiating the transaction involves a series of procedural steps with the insurance company. The process typically begins by contacting the insurer directly. This can be done through various channels, such as calling their customer service line, accessing their online policy portal, or reaching out to the insurance agent or financial advisor who helped establish the policy.

When contacting the insurance company, the policyholder should be prepared to provide essential identification details, including their full name, date of birth, and the policy number. The insurer will then typically guide the policyholder on the specific forms required for the chosen transaction, whether it is a policy surrender, a loan, or a partial withdrawal. These forms often require signatures and may need to be notarized to ensure authenticity.

After obtaining the necessary forms, the policyholder must carefully complete them, ensuring all requested information is accurate. This includes specifying the amount of cash value to be accessed and the preferred method of receiving funds, such as direct deposit or a check. Once completed, the forms should be submitted to the insurance company according to their instructions, which may involve mailing physical documents or submitting them electronically through a secure online portal.

Upon submission, the insurance company will process the request, which can take several business days to a few weeks, depending on the complexity of the transaction and the insurer’s internal procedures. The policyholder should expect to receive confirmation once the request is being processed and an update when the funds are disbursed. It is advisable to keep copies of all submitted documents and correspondence for personal records.