Can You Cash In a Term Life Insurance Policy?

Term life insurance policies do not build a cash value that policyholders can access during their lifetime. A common misunderstanding involves whether these policies can be “cashed in” by the policyholder.

The Core Function of Term Life Insurance

Term life insurance is designed to provide financial protection for a specific period. This term can range from 10 to 30 years, aligning with periods of significant financial responsibility such as raising a family or paying off a mortgage. It operates as pure protection, meaning the premiums paid cover only the risk of the insured’s death within the defined timeframe.

Premiums for term life insurance are fixed for the duration of the policy. These payments directly fund the death benefit that would be paid to beneficiaries if the insured passes away during the active term. Because the focus is solely on providing coverage for a set period without a savings component, term life insurance does not generate cash value. This fundamental design makes it a more affordable option compared to other types of life insurance.

Distinguishing Cash Value Policies

In contrast to term life insurance, certain permanent life insurance policies, such as whole life and universal life, are designed to accumulate cash value over time. A portion of each premium paid into these policies is allocated to a cash value component, which then grows on a tax-deferred basis. This growth can occur through guaranteed interest rates, as often seen in whole life policies, or through variable rates tied to market performance or declared interest, common in universal life policies.

Policyholders can access this accumulated cash value in several ways while the insured is still living. One common method is taking a policy loan, where the cash value serves as collateral. These loans are generally not taxed unless the policy lapses with an outstanding loan.

Another option is to make partial withdrawals, which reduce the policy’s death benefit and can be tax-free up to the amount of premiums paid into the policy. Any withdrawals exceeding the basis may be subject to income tax. Policyholders can also surrender the policy entirely for its cash surrender value, which cancels the coverage and may incur surrender charges, with any gain above the premiums paid being taxable.

Policy Outcomes for Term Life

When a standard term life insurance policy reaches the end of its specified term, the coverage expires. If the policyholder is still alive, the policy terminates, and no value is returned, as the premiums paid covered the insurance risk. Similarly, if a term policy is canceled prematurely, no refund of premiums is provided. An exception exists for cancellations within a “free-look period,” often 10 to 30 days after purchase, during which a full refund may be issued.

Some term policies offer a “return of premium” (ROP) rider, which, for a higher premium cost, refunds all or a portion of the premiums paid if the policyholder outlives the term. Another outcome for a term policy is the option to convert it to a permanent life insurance policy. Many term policies include a conversion privilege, allowing conversion to a whole life or universal life policy within a specific timeframe, often without requiring a new medical exam. While the original term policy does not have cash value, the converted permanent policy will begin to accumulate it.

A terminally or chronically ill policyholder might consider a viatical settlement. This involves selling the policy to a third party for a lump sum, which is generally tax-free under federal law if certain conditions related to health and life expectancy are met. This is not “cashing in” the policy in the traditional sense, but rather selling the death benefit to a third-party investor.