Can Life Insurance Be Cashed In by the Insured if the Owner Dies?

Life insurance policies are financial tools that provide monetary support to designated individuals or entities upon the passing of the insured. A common point of confusion arises when the policy owner, who controls the policy, passes away, and questions emerge about the insured’s ability to access the policy’s value. The answer depends on the specific roles involved and the type of insurance held, particularly the presence of an accumulated cash value.

Understanding Policy Roles and Cash Value

A life insurance policy involves distinct roles, each with specific rights and responsibilities. The policy owner is the individual or entity that purchases the policy and has full control over it, including the ability to change beneficiaries, surrender the policy, or access its cash value. The insured is the person whose life is covered by the policy, and whose death triggers the payment of the death benefit. The beneficiary is the person or entity designated to receive the death benefit when the insured passes away. These roles can be held by different individuals or by the same person.

Permanent life insurance policies, such as whole life or universal life, build a cash value over time. This cash value is a savings component separate from the death benefit. A portion of each premium payment contributes to this cash value, which grows on a tax-deferred basis. The policy owner can access this accumulated cash value during their lifetime. In contrast, term life insurance policies do not accumulate cash value, as they focus solely on providing a death benefit for a specific period.

Transferring Policy Ownership After the Owner’s Death

When a life insurance policy owner passes away, the policy is considered an asset, similar to other property, and becomes part of the deceased owner’s estate. This occurs unless a successor owner was specifically named within the policy documents. The transfer of policy ownership generally follows the deceased’s estate plan.

If the deceased policy owner had a will, its instructions typically dictate how ownership is transferred, such as to an executor or a specific heir. If the policy was held in a trust, its terms govern the succession of ownership. Without specific instructions or a trust, ownership usually passes through probate, a legal procedure where the court oversees the distribution of assets.

During probate, a court-appointed executor or administrator manages the estate and facilitates ownership transfer. The insured individual does not automatically become the new owner upon the original owner’s death. Ownership transfers to the insured only if they are designated as a successor owner in the policy, named in the will, or awarded ownership through the probate process.

Accessing Policy Cash Value After Ownership Transfer

Once a new policy owner is legally established, they gain full control over the life insurance policy, including the rights to its accumulated cash value. This means the new owner can decide how to utilize the cash value, which can be accessed through several methods.

One common method is policy surrender, where the owner terminates the policy and receives its cash surrender value. The cash surrender value is the accumulated cash value minus any applicable surrender charges and outstanding policy loans. Surrendering the policy ends all coverage, meaning no death benefit will be paid later.

Another option for accessing cash value is to take a policy loan against it. The new owner can typically borrow up to a certain percentage of the policy’s cash value. While interest accrues on these loans, repayment schedules are often flexible, and the policy remains in force as long as premiums are paid and sufficient cash value remains to cover loan interest. However, any outstanding loan balance, including accrued interest, will reduce the death benefit paid to beneficiaries.

Policy owners may also be able to make withdrawals from the cash value, depending on the policy type, such as universal life insurance. Withdrawals directly reduce the policy’s cash value and can also decrease the death benefit. The insured person can only “cash in” the policy by accessing its cash value if they have become the legally recognized new owner. Without legal ownership, the insured has no right to access the cash value.

Key Considerations for the New Policy Owner

Upon assuming ownership of a life insurance policy, the new owner should be aware of several important financial implications. Accessing the cash value, particularly through a full surrender, may have tax consequences. If the amount received from a surrender or withdrawal exceeds the total premiums paid into the policy, the difference may be subject to ordinary income tax. For example, if $50,000 in premiums were paid and the cash value is $60,000, the $10,000 gain could be taxable income.

Any action taken to access the cash value directly impacts the death benefit intended for beneficiaries. Surrendering the policy eliminates the death benefit entirely, as the policy is terminated. Taking a policy loan or making withdrawals will reduce the death benefit by the amount of the loan or withdrawal, plus any unpaid interest on loans. This reduction can significantly alter the financial protection initially intended for the beneficiaries.

Existing outstanding policy loans from the previous owner will also reduce the policy’s cash value and, consequently, the death benefit. The new owner becomes responsible for managing these loans or understanding their impact on the policy’s future payout. Finally, reviewing and updating the beneficiary designation is a significant step for the new owner. The original owner’s beneficiary choices may not align with the new owner’s intentions, and updating this designation ensures the death benefit will be paid to the intended recipients.