Can You Cash In a Life Insurance Policy?

Certain types of life insurance policies can accumulate a cash value that policyholders may be able to access during their lifetime. This feature allows individuals to utilize a portion of their policy’s value while still living, providing financial flexibility beyond the traditional death benefit. Understanding how this cash value works and the various ways to access it can be an important aspect of personal financial planning.

Life Insurance Policies with Cash Value

Cash value in a life insurance policy represents a savings component that grows over time, separate from the death benefit. A portion of each premium payment is allocated to this cash account, where it accumulates on a tax-deferred basis. This accumulation is influenced by factors such as the policy type, premium payment history, and any interest or investment returns credited to the account.

Several types of permanent life insurance policies include a cash value feature. Whole life insurance, for instance, offers a guaranteed death benefit, fixed premiums, and a cash value that grows at a guaranteed interest rate. Universal life insurance provides more flexibility, allowing adjustments to premium payments and death benefits, with cash value growth often tied to a market-based interest rate, though typically with a guaranteed minimum.

Variable universal life insurance allows policyholders to allocate their cash value to various investment sub-accounts, similar to mutual funds, offering potential for higher returns but also greater risk as cash value can fluctuate with market performance. Indexed universal life insurance links cash value growth to the performance of a specific market index, such as the S&P 500, often providing a minimum guaranteed interest rate and a cap on potential gains. Term life insurance does not build cash value because it provides coverage for a specific period without an investment component.

Methods for Accessing Cash Value

Policyholders have several distinct methods to access the accumulated cash value within their life insurance policy. Each method has its own mechanics and implications for the policy’s future. The choice among these options often depends on the policyholder’s financial needs and long-term objectives.

One direct method is policy surrender, which involves canceling the insurance coverage in exchange for the policy’s cash surrender value. This value is typically the accumulated cash value minus any applicable surrender charges or outstanding loans. Surrendering the policy ends the death benefit. The amount received can vary significantly, especially if the policy is surrendered early, as surrender charges can be substantial for the first 10 to 15 years.

Another common approach is taking a policy loan against the accumulated cash value. This is not a traditional loan from a bank but rather a loan from the insurer, with the policy’s cash value serving as collateral. Policy loans do not require a credit check and often have competitive interest rates. Any outstanding loan balance, plus accrued interest, will reduce the death benefit paid to beneficiaries if the loan is not fully repaid.

Policyholders can also make withdrawals from their cash value. This allows access to a portion of the funds without terminating the policy. Withdrawals directly reduce the policy’s cash value and, consequently, the death benefit. While some policies, like universal life, allow partial withdrawals, whole life policies typically only allow access through loans without lapsing the policy.

For those facing significant health challenges or who no longer need their policy, viatical settlements and life settlements offer alternative ways to access funds. A viatical settlement involves selling the policy to a third-party company for a lump sum, typically for policyholders with a terminal or chronic illness and a shortened life expectancy, often two years or less. A life settlement is similar but available to older policyholders, usually over 65, who may not be terminally ill but wish to sell their policy for cash. In both settlement types, the buyer assumes premium payments and receives the death benefit upon the insured’s death. The payout received is typically more than the cash surrender value but less than the full death benefit.

Tax and Financial Considerations

Accessing a life insurance policy’s cash value involves important tax and financial implications that policyholders should carefully consider. The method chosen directly impacts the net amount received and the policy’s future status. Understanding these consequences is essential for informed decision-making.

A primary financial consideration is the impact on the policy’s death benefit. Any access to cash value through loans, withdrawals, or surrenders will directly reduce or potentially eliminate the original death benefit. For example, an outstanding policy loan, if not repaid, will be deducted from the death benefit when the insured passes away. Similarly, withdrawals directly decrease the cash value, which then lowers the amount beneficiaries will receive.

The taxation of withdrawals and loans follows a “cost basis” rule. Amounts received up to the total premiums paid into the policy (the cost basis) are considered a tax-free return of principal. However, any portion of a withdrawal that exceeds the cost basis is taxable as ordinary income. Policy loans are tax-free, provided the policy remains in force. If a policy lapses with an outstanding loan, the loan amount exceeding the cost basis can become taxable.

When a policy is surrendered, any amount received that exceeds the total premiums paid is taxable as ordinary income. For instance, if a policyholder paid $50,000 in premiums and receives $60,000 upon surrender, the $10,000 gain would be taxable. Surrender charges, which can be substantial in the early years of a policy, will reduce the net cash received.

Viatical and life settlements have specific tax rules that differ from direct cash value access. Proceeds from viatical settlements for terminally or chronically ill individuals are not subject to federal income tax. For life settlements, the proceeds up to the cost basis are tax-free, amounts exceeding the basis up to the cash surrender value are taxed as ordinary income, and any amount received above the cash surrender value can be taxed as capital gains. Administrative fees or charges may apply to these transactions, further reducing the net payout.

Steps to Access Your Policy’s Cash Value

Accessing your life insurance policy’s cash value involves a series of practical, procedural steps. Initiating this process requires careful attention to detail and direct communication with your insurance provider.

Begin by gathering all relevant policy documents, including your policy number and the contact information for your insurance provider or agent. Review your specific policy terms to understand the details of cash value access, including any potential fees or limitations. This initial information gathering will streamline subsequent interactions with the insurer.

Next, contact your insurance company through their customer service line, online policyholder portal, or directly with your agent. Clearly state your intent, whether you wish to request a policy loan, make a withdrawal, or explore a surrender or settlement option. The insurer will then guide you on the specific requirements for your chosen method.

Request the necessary forms and detailed instructions for accessing your cash value. For a policy loan or withdrawal, this might involve a simple request form specifying the desired amount. For a surrender, a surrender request form will be required, and for settlements, you will likely work with a third-party provider and broker who will facilitate the application process.

Carefully complete all required fields on the forms, ensuring accuracy and providing any requested supporting documentation, such as identification or medical records for settlements. Submit the completed forms through the designated channels, which may include mail, online upload, or fax. Confirm receipt of your submission to track its progress.

After submission, anticipate a processing period, which can range from a few business days for withdrawals or loans to several weeks for surrenders, and potentially several months for life settlements. Funds are disbursed via check or direct deposit. You should also receive confirmation of the transaction and any changes to your policy’s status, such as a reduced death benefit or policy termination.