Can I Cash Out a Term Life Insurance Policy?

Life insurance offers a death benefit to beneficiaries upon the insured’s passing. While permanent policies like whole or universal life often accumulate cash value, term life insurance operates differently. Term policies generally do not build cash value and are not designed to provide a living benefit that policyholders can withdraw or borrow against.

The Nature of Term Life Insurance

Term life insurance provides coverage for a specific period, typically 10 to 30 years. Its primary purpose is to offer financial protection, ensuring beneficiaries receive a death benefit if the insured dies within that term. This policy type is structured purely for protection and does not include a savings or investment component.

Unlike permanent life insurance, which builds cash value that can grow tax-deferred and be accessed, term life insurance has no such feature. Premiums paid for a term policy are solely for the cost of coverage for that period. If the insured outlives the policy term, there is typically no payout or financial return on premiums paid, unless a return of premium rider was added.

Exploring Policy Options

Since term life policies do not accumulate cash value, directly “cashing them out” is not an option. However, policyholders have several avenues to consider if their coverage needs change or if they wish to derive value from an existing term policy. These options involve distinct processes and financial implications.

One common option is policy conversion, where some term policies allow conversion to a permanent life insurance policy. This typically occurs without a new medical examination, even if the insured’s health has declined. It transforms temporary coverage into a lifelong policy, which then has the potential to build cash value.

Another option is a life settlement, which involves selling the term life insurance policy to a third-party buyer. The policy owner receives a lump sum payment that is typically greater than the policy’s cash surrender value (which is usually zero for term policies) but less than the full death benefit. The new owner then assumes responsibility for paying future premiums and receives the death benefit when the insured dies. Eligibility for a life settlement often depends on factors such as the policy’s death benefit size, the insured’s age, and health status.

Some term policies may include an accelerated death benefit rider, also known as a living benefit. This feature allows the policyholder to access a portion of the death benefit while still alive, typically under specific circumstances such as a terminal or chronic illness diagnosis. The funds received can be used for medical expenses or other needs, and the amount accessed reduces the death benefit eventually paid to beneficiaries.

Finally, a policyholder can choose to let the term policy lapse or formally surrender it. Lapsing occurs when premium payments are stopped, leading to the termination of coverage. For term life insurance, this generally means no financial return to the policyholder, as there is no cash value. All premiums paid up to that point are forfeited, and the coverage ceases.

Understanding the Financial Impact

Each option for managing a term life insurance policy carries distinct financial and tax implications. Converting a term policy to a permanent one, while offering lifelong coverage and cash value accumulation, will result in significantly higher premiums. This increased cost reflects the lifetime coverage and the cash value component that begins to build, which can take several years to accumulate substantial value.

For life settlements, the lump sum received from selling the policy has tax implications. The amount received up to the total premiums paid is considered a return of basis and is not taxable. Any proceeds exceeding the premiums paid, up to the policy’s cash surrender value, are typically taxed as ordinary income. Since term life policies generally have no cash surrender value, any amount received above the premiums paid is usually taxed as a capital gain. A notable exception is a viatical settlement, where the policyholder is terminally or chronically ill; proceeds from these settlements are generally tax-free.

Accelerated death benefits are generally tax-exempt if the insured is certified as terminally ill. For chronically ill individuals, these benefits can also be tax-free if used for qualified long-term care expenses, subject to IRS limits. However, receiving these benefits reduces the eventual death benefit paid to beneficiaries, and exceeding IRS limits or not meeting qualifying conditions can result in taxable income.

Lapsing or surrendering a term life insurance policy typically results in a complete financial loss of all premiums paid. Because term policies do not build cash value, there is no surrender value. If the policy is allowed to lapse, the insured loses the coverage and any financial investment made through premium payments.