Can I Cash Out My Term Life Insurance?

Term life insurance provides financial protection for a specific period, such as 10, 20, or 30 years. It offers a death benefit to beneficiaries if the insured person passes away within the policy’s term. Unlike other life insurance policies, term life does not accumulate a cash value component. Therefore, it cannot be “cashed out.”

Understanding Term Life Insurance and Cash Value

Term life insurance and permanent life insurance differ fundamentally in their structure and purpose. Term life policies provide a death benefit for a predetermined period, acting purely as coverage without an investment or savings element. This temporary nature is a primary reason why term life insurance is generally more affordable than permanent options.

In contrast, permanent life insurance, such as whole life or universal life, offers lifelong coverage and includes a “cash value” component. This cash value is a savings feature that accumulates over time as premiums are paid, and it can grow on a tax-deferred basis. Policyholders with permanent policies can access this accumulated cash value through withdrawals or loans while they are still alive.

Term life insurance premiums primarily cover the cost of the death benefit, without allocating funds towards a cash value account. This design makes term policies straightforward and cost-effective for covering temporary financial needs, such as a mortgage or supporting dependents. Since term life policies lack this savings component, there is no cash value to withdraw or borrow against.

Cancelling a Term Life Policy

When a policyholder cancels a term life insurance policy or allows it to lapse by ceasing premium payments, the coverage simply ends. Unlike permanent life policies that build cash value, there is no surrender value or payout provided upon cancellation. The premiums paid are generally not refunded.

If a policyholder stops paying premiums, most term policies include a grace period, typically around 30 to 31 days, during which coverage remains in force. After this grace period expires without payment, the policy will lapse, and all coverage ceases. Cancelling a term policy means forfeiting any future death benefit, as the policy terminates.

A rare exception is a “return of premium” rider, which can refund some or all premiums if the insured outlives the term or cancels the policy. However, policies with this rider usually come with significantly higher premiums. In most standard term life scenarios, cancelling or allowing the policy to lapse results in no financial return to the policyholder.

Exploring Other Options for Accessing Funds

While term life insurance does not offer cash value, policyholders might explore alternative methods to access funds under specific circumstances. These options are distinct from cashing out a policy.

Life Settlements

One option is a life settlement, where the policy owner sells their existing life insurance policy to a third-party investor for a lump sum. This amount is typically greater than any cash surrender value (which is zero for term policies) but less than the full death benefit. Life settlements are generally considered by individuals aged 65 or older, or younger individuals with significant health impairments. Policies often need a face value of $100,000 or more. The process involves an application, submission of documentation, and a review by life expectancy underwriters to assess the insured’s lifespan, which is a key factor in the policy’s market value.

Accelerated Death Benefits (ADBs)

Another avenue for accessing funds is through Accelerated Death Benefits (ADBs), provisions or riders included in some life insurance policies. ADBs allow policyholders to receive a portion of their death benefit while still living, typically under severe health conditions. For instance, a terminal illness might be defined as having a life expectancy of 24 months or less. Chronic illness often involves the inability to perform a certain number of daily living activities. Accessing an ADB reduces the eventual death benefit paid to beneficiaries. The process generally involves obtaining a doctor’s statement, contacting the insurance company, and submitting a claim form for review and approval. Many life insurance companies include an ADB rider in their policies, though a processing fee might be deducted from the benefit paid.

Tax Considerations for Policy Access

Accessing funds from a life insurance policy through mechanisms like life settlements or accelerated death benefits involves specific tax implications that differ from the generally tax-free nature of a traditional death benefit paid to beneficiaries.

Tax on Life Settlements

For life settlements, the proceeds may be subject to income tax. The Internal Revenue Service (IRS) applies a three-tiered tax structure to these transactions.

First, the portion of proceeds up to the policyholder’s “cost basis” (total premiums paid) is received tax-free. Second, any proceeds exceeding the cost basis but not exceeding the policy’s cash surrender value (if applicable) are taxed as ordinary income. Finally, any remaining proceeds above the cash surrender value are taxed as long-term capital gains. For term life policies, which have no cash surrender value, proceeds beyond the cost basis might be treated primarily as capital gains.

Tax on Accelerated Death Benefits

Accelerated Death Benefits (ADBs) generally receive favorable tax treatment under Internal Revenue Code Section 101. Amounts received as ADBs are typically excluded from taxable income if the policyholder is certified as terminally ill. For chronically ill individuals, ADBs are also generally tax-free, provided the funds are used for qualified long-term care expenses. However, there is an annual per diem limit set by the IRS for tax-free chronic illness benefits. Any amount received exceeding this limit may be taxable. It is advisable to consult with a qualified tax professional for personalized advice regarding these complex tax rules.