Can You Cash In a Life Insurance Policy?

Life insurance policies primarily offer a financial safeguard for beneficiaries upon the policyholder’s death. Certain types of life insurance can also serve as a financial resource during the policyholder’s lifetime. Understanding how to access these funds and the associated considerations is important.

Policies with Cash Value

Not all life insurance policies offer the ability to access funds during the policyholder’s lifetime; this feature is associated with permanent life insurance. Permanent policies, such as whole life, universal life, and variable universal life, accumulate a cash value component over time. Term life insurance policies, designed for a specific period, do not build cash value.

The cash value within a permanent life insurance policy represents a portion of premium payments that grows on a tax-deferred basis. This accumulated amount develops alongside the death benefit. Cash value grows through guaranteed interest rates, as in whole life policies, or through market-linked investment performance, common with variable universal life policies. Growth is net of policy fees, administrative charges, and the cost of insurance.

Methods to Access Cash Value

Policyholders with permanent life insurance have several avenues to access the accumulated cash value directly from the insurance company. Each method involves distinct procedural steps and has different implications for the policy’s continued coverage and death benefit.

One way to access funds is through a policy surrender, which terminates the life insurance contract entirely. The policyholder contacts their insurer to request a surrender form. Upon processing, the insurer pays out the policy’s cash surrender value, which is the accumulated cash value less any outstanding loans, unpaid premiums, or applicable surrender charges. This action immediately ceases the policy’s death benefit and coverage.

Another method involves taking a policy loan, where the policyholder borrows money directly from the insurer, using the cash value as collateral. Policyholders contact their insurer to understand the available loan amount. The loan amount can be a significant portion of the cash value, often 75% to 90%, and interest accrues on the borrowed sum. The policy remains in force as long as the loan balance, plus accrued interest, does not exceed the cash value, which could otherwise lead to policy lapse.

Policyholders can also make partial withdrawals from the cash value of certain permanent life insurance policies, such as universal life. The policyholder submits a formal request to the insurer, specifying the desired amount. Unlike a loan, a withdrawal directly reduces the policy’s cash value and, consequently, the death benefit by the amount withdrawn. These withdrawals are irreversible and do not need to be repaid.

Selling Your Policy

Beyond accessing cash value directly from the insurer, policyholders can also sell their life insurance policy to a third party. This option provides an alternative for individuals who no longer need their policy and seek a lump sum payment.

A life settlement involves selling an existing life insurance policy to a third-party investor for a cash sum. This amount is greater than the policy’s cash surrender value but less than the full death benefit. Policyholders consider a life settlement when financial needs change, making premiums burdensome or the policy unnecessary. The process begins with an application to a life settlement provider, followed by a review of medical records and policy details to determine an offer.

A viatical settlement is a specific type of life settlement for policyholders who are terminally or chronically ill. The policyholder sells their life insurance policy to a third party to receive a portion of the death benefit while still alive. This option is pursued to cover medical expenses or improve quality of life during an illness. The process involves an application, medical underwriting to confirm eligibility, and an offer from a viatical settlement provider.

Financial and Tax Implications

Accessing funds from a life insurance policy, whether directly from the insurer or by selling the policy, carries important financial and tax considerations. The specific impact depends on the method chosen and the policy’s financial structure.

Withdrawals or policy loans from cash value are generally tax-free up to the policyholder’s cost basis, which refers to the total premiums paid into the policy. Any amount received in excess of the cost basis is taxable as ordinary income under Internal Revenue Code Section 72. For a policy surrender, any gain realized—the cash surrender value minus the total premiums paid—is also taxable as ordinary income.

When a policy is sold through a life settlement or viatical settlement, the tax treatment of proceeds can be complex. The portion of proceeds up to the policy’s cost basis is received tax-free. Proceeds exceeding the cost basis but not exceeding the cash value may be taxed as ordinary income, while any amount received above the cash value could be taxed as a capital gain. For viatical settlements, if the policyholder meets the criteria for terminal or chronic illness as defined by Internal Revenue Code Section 101(g), the proceeds may be entirely tax-exempt. Consulting a tax professional is advisable to understand specific tax liabilities.

Accessing cash value through loans or withdrawals, or surrendering the policy, directly impacts the death benefit. A policy loan reduces the death benefit payable to beneficiaries by the outstanding loan amount plus any accrued interest if not repaid. Withdrawals permanently reduce both the cash value and the death benefit. Surrendering the policy eliminates the death benefit entirely.

Early surrenders of a permanent life insurance policy may incur surrender charges, which are fees deducted from the cash value when the policy is terminated within a certain number of years, often the first 10 to 15 years. These charges can reduce the amount the policyholder receives upon surrender. If policy loans are left unpaid and the loan balance, including interest, grows to exceed the policy’s cash value, the policy can lapse. A policy lapse means coverage ends, and any outstanding loan balance becomes immediately taxable as ordinary income to the extent it exceeds the policy’s cost basis.