Can You Cash In Life Insurance Before You Die?

It is possible to access funds from a life insurance policy before the insured’s death. This capability primarily applies to specific types of life insurance policies that accumulate cash value over time. Understanding how these policies function and the various methods available for accessing their accumulated value is important for policyholders. This process involves several considerations, including financial impacts and tax implications, which require careful review.

Understanding Life Insurance Cash Value

Cash value in a life insurance policy represents a component that grows over the policy’s lifetime, separate from the death benefit. A portion of each premium payment contributes to this cash value, which then accumulates interest or earns investment returns. This accumulation provides a living benefit that policyholders can access while the policy is still active.

Whole life insurance, universal life insurance, and variable universal life insurance are examples of policies designed to build cash value. Whole life policies offer guaranteed cash value growth and a fixed premium, providing predictability. Universal life policies offer more flexibility in premium payments and death benefits, with cash value growth tied to an interest rate.

Variable universal life policies allow policyholders to invest the cash value in various sub-accounts, offering potential for higher returns but also greater risk. Term life insurance, by contrast, is designed purely for death benefit protection over a specific period and typically does not accumulate any cash value.

Methods to Access Your Policy’s Value

Several distinct methods allow policyholders to access the accumulated value within their life insurance policy. Each method offers a different approach to utilizing the policy’s cash component, depending on the policyholder’s financial needs and goals. Understanding these options is crucial for making an informed decision about your policy.

One method is a policy surrender, where the policyholder chooses to terminate the life insurance contract entirely. Upon surrender, the insurance company pays out the accumulated cash surrender value, which is the cash value minus any outstanding loans or surrender charges. This action effectively ends the coverage, and no death benefit will be paid upon the insured’s passing.

Policyholders can also take policy loans against their accumulated cash value. With this option, the insurer provides funds, and the cash value acts as collateral for the loan. The policy remains in force, and the loan accrues interest, which must be repaid. If the loan is not repaid, the outstanding balance and any accrued interest will reduce the death benefit paid to beneficiaries.

Another way to access funds is through partial withdrawals from the policy’s cash value. This method allows the policyholder to take out a portion of the cash value without completely surrendering the policy. Unlike a loan, a withdrawal reduces the policy’s cash value and the death benefit directly and permanently. Future premium payments may be required to maintain the policy’s original death benefit.

Accelerated Death Benefits (ADBs), also known as living benefits, provide access to a portion of the death benefit under specific qualifying circumstances. These circumstances typically include a terminal illness with a life expectancy of 12 to 24 months, chronic illness requiring assistance with daily activities, or critical illness such as a heart attack or stroke. The specific conditions and the percentage of the death benefit accessible vary by policy and insurer.

For those not terminally ill, a life settlement offers an option to sell the life insurance policy to a third-party company for a lump sum. This amount is typically more than the policy’s cash surrender value but less than the full death benefit. Policyholders considering this option are usually older, often over 65, and may have declining health or no longer need the coverage. The buyer of the policy assumes responsibility for future premium payments and receives the death benefit when the insured passes away.

A viatical settlement is similar to a life settlement but specifically applies to policyholders who are terminally or chronically ill. In this arrangement, the policy is sold to a third party for a lump sum, which is generally a higher percentage of the death benefit than a life settlement due to the shorter life expectancy. The funds from a viatical settlement are often used to cover medical expenses or improve the quality of life during the remaining time.

Financial and Tax Implications of Accessing Funds

Accessing your life insurance policy’s value before death carries distinct financial and tax implications for each method. Understanding these consequences is essential to avoid unexpected financial burdens or tax liabilities. The impact on the policy’s death benefit and the tax treatment of received funds vary significantly by the chosen option.

When performing a policy surrender, the cash surrender value received is generally tax-free up to the amount of premiums paid into the policy, known as the cost basis. Any amount received that exceeds this cost basis is typically taxable as ordinary income. For example, if you paid $50,000 in premiums and receive $60,000 upon surrender, the $10,000 gain would be subject to ordinary income tax rates.

Policy loans are generally tax-free as long as the policy remains in force. If the policy lapses with an outstanding loan, the loan amount exceeding your cost basis can become taxable as ordinary income. Unpaid loan balances and accrued interest will also directly reduce the death benefit paid to your beneficiaries, potentially leaving them with less than anticipated.

Partial withdrawals from a policy’s cash value are generally treated on a “first-in, first-out” (FIFO) basis for tax purposes. Withdrawals are considered a return of your premiums (cost basis) first, which are tax-free. Once the total withdrawals exceed the premiums paid, any further amounts withdrawn are subject to ordinary income tax. These withdrawals also permanently reduce the policy’s cash value and the death benefit.

Accelerated Death Benefits are typically tax-free if the insured meets specific health criteria, such as being certified as terminally ill with a life expectancy of 24 months or less, or chronically ill. Under the Health Insurance Portability and Accountability Act (HIPAA), payments received from an accelerated death benefit are generally excluded from gross income. The remaining death benefit paid to beneficiaries will be reduced by the amount of the accelerated benefit received.

For life settlements, the tax implications can be more complex. A portion of the proceeds equal to your cost basis (premiums paid) is generally tax-free. Any gain above your cost basis, up to the policy’s cash surrender value, is typically taxed as ordinary income. Any gain exceeding the cash surrender value is generally taxed as a capital gain. For instance, if your cost basis is $100,000, cash surrender value is $150,000, and you receive $200,000 from a settlement, $100,000 is tax-free, $50,000 is ordinary income, and $50,000 is capital gains.

Viatical settlements receive more favorable tax treatment under HIPAA for terminally or chronically ill individuals. Payments from a viatical settlement are generally excluded from gross income, similar to accelerated death benefits, provided the insured meets the medical requirements for being terminally or chronically ill. This tax exclusion helps ensure that individuals facing severe health challenges can access their policy’s value without additional tax burdens.

Steps to Access Your Policy’s Value

Initiating the process to access your life insurance policy’s value involves several practical steps to ensure a smooth transaction. The specific actions required will depend on the method you choose, but a general framework applies to most situations. Following these steps helps streamline the process and ensures you provide all necessary information.

The first and most important step is to contact your life insurance company directly or reach out to your financial advisor. They can provide accurate information about your specific policy, including its current cash value, any outstanding loans, and the exact procedures for accessing funds. This initial contact will clarify eligibility requirements and available options tailored to your policy.

During this contact, you will need to provide specific information for identification and policy verification. This typically includes your policy number, full legal name, date of birth, and possibly other identifying details to confirm you are the policyholder. Having your policy documents readily available will expedite this information-gathering phase.

Next, you will be required to complete specific forms and documentation corresponding to the type of transaction you wish to perform. For a policy surrender, a surrender request form is needed. For a policy loan or partial withdrawal, a loan application or withdrawal request form will be necessary. If pursuing accelerated death benefits, medical certifications from a physician stating your terminal or chronic illness will be required.

After submitting the necessary forms and supporting documents, the insurance company will begin its review and approval process. This process can vary in length, from a few days for simple loans or withdrawals to several weeks or months for accelerated death benefits or settlement options, especially if medical underwriting is involved. For settlements, third-party buyers will also conduct their own review.

Finally, once approved, the insurance company will proceed with processing and disbursing the funds. The processing timelines can range from approximately 5 to 10 business days for a policy loan or withdrawal, to 2 to 4 weeks for a surrender, and potentially longer for accelerated death benefits or settlements which may involve more extensive review. Funds are typically disbursed via direct deposit or check, depending on your preference and the insurer’s capabilities.