Can You Cash In Your Life Insurance?

Life insurance policies primarily offer a financial safety net for beneficiaries upon the policyholder’s passing. Certain types of life insurance policies accumulate a cash value component that can be accessed during the policyholder’s lifetime, often called “cashing in” the policy. Only permanent life insurance policies typically develop a cash value.

Types of Life Insurance with Cash Value

Cash value life insurance refers to permanent life insurance policies that integrate a savings or investment feature alongside the death benefit. Three common types that build cash value are whole life, universal life, and variable universal life. Each type accumulates cash value differently, offering varying predictability and growth. Term life insurance policies, designed for a specific period, generally do not possess a cash value component and cannot be “cashed in.”

Whole life insurance policies accumulate cash value at a guaranteed interest rate, providing predictable growth. A portion of each premium payment is allocated to this cash value account, which grows on a tax-deferred basis. Universal life insurance offers more flexibility, with cash value growth often tied to current interest rates set by the insurer or linked to market performance, typically with a guaranteed minimum rate. Policyholders can adjust premium payments or the death benefit within limits; excess premiums may contribute to faster cash value accumulation.

Variable universal life insurance policies allow policyholders to invest the cash value in various sub-accounts, similar to mutual funds. This offers the potential for higher returns, but also carries investment risk, meaning the cash value can fluctuate based on market performance. These policies provide flexibility in managing the investment component and adjusting premiums. Poor investment performance could reduce the cash value and potentially require higher premium payments to maintain coverage. Indexed universal life insurance, a type of universal life, ties cash value growth to a stock market index, offering growth potential with some protection against market downturns through guaranteed minimum interest rates.

Methods to Access Policy Value

Policyholders have several distinct methods to access the cash value accumulated within their life insurance. One direct approach is a policy surrender, which involves terminating the life insurance policy entirely. Upon surrender, the insurer pays the policyholder the cash surrender value, which is the accumulated cash value less any outstanding loans, unpaid premiums, or applicable surrender charges. This immediately ends coverage, meaning no death benefit will be paid.

Another common method is taking a policy loan, where the policyholder borrows money directly from the insurer, using the policy’s cash value as collateral. This process does not require a credit check or loan approval, offering a flexible and often lower-interest alternative to traditional loans. The policy remains in force, and the cash value continues to accrue interest or earnings. Any outstanding loan balance, plus accrued interest, will reduce the death benefit paid to beneficiaries if the insured passes away before repayment.

Policyholders can also opt for a partial withdrawal, which allows them to take out a portion of the cash value without fully terminating the policy. This method directly reduces the policy’s cash value and typically results in a corresponding reduction in the death benefit. Unlike a loan, a withdrawal does not usually need to be repaid. The amount and frequency of partial withdrawals may have limits set by the insurer. Excessive withdrawals could risk the policy lapsing if the remaining cash value is insufficient to cover ongoing policy costs.

An accelerated death benefit feature allows policyholders to access a portion of their death benefit while still alive, under specific qualifying circumstances. These circumstances typically involve a diagnosis of a terminal illness with a limited life expectancy, or a chronic illness preventing the individual from performing daily living activities. The funds received can be used for medical expenses, long-term care, or other needs, but the remaining death benefit for beneficiaries will be reduced by the amount advanced.

Finally, a life settlement involves selling the entire life insurance policy to a third-party buyer for a lump sum. This lump sum is generally greater than the policy’s cash surrender value but less than the full death benefit. The buyer then becomes the new policy owner, assumes responsibility for all future premium payments, and receives the death benefit upon the insured’s passing. A specific type of life settlement, a viatical settlement, is reserved for individuals with a terminal or chronic illness, often with a life expectancy of two years or less.

Financial and Tax Implications

Each method of accessing life insurance cash value carries distinct financial and tax implications. For a policy surrender, any amount received exceeding the total premiums paid (cost basis) is typically taxable as ordinary income. For instance, if $50,000 was paid in premiums and the surrender value is $60,000, the $10,000 gain would be taxable. Surrendering the policy means the loss of all life insurance coverage and potential surrender charges, particularly if the policy is relatively new.

Policy loans are generally not considered taxable income, as they are treated as a debt against the policy’s cash value rather than a distribution of earnings. Interest accrues on the loan. If the loan balance, including accrued interest, exceeds the cash value and the policy lapses or is surrendered, the outstanding loan amount that exceeds the cost basis can become immediately taxable as ordinary income. An unpaid loan also permanently reduces the death benefit paid to beneficiaries.

Partial withdrawals are typically tax-free up to the amount of premiums paid into the policy, which represents a return of the policyholder’s cost basis. Any withdrawal amount exceeding this cost basis is usually taxable as ordinary income. For example, if $40,000 in premiums were paid and a $50,000 withdrawal is made, the first $40,000 is tax-free, but the remaining $10,000 is taxable. These withdrawals directly reduce the policy’s cash value and, consequently, the death benefit.

Accelerated death benefits are generally tax-exempt under federal law, provided the insured meets specific criteria. This includes being certified as terminally ill with a life expectancy of 24 months or less, or chronically ill and unable to perform at least two activities of daily living. If chronically ill, payments must be used for qualified long-term care expenses, or amounts exceeding certain limits may be taxable. These benefits reduce the ultimate death benefit payable to beneficiaries and can impact eligibility for certain government assistance programs like Medicaid.

For life settlements, the tax treatment is more complex. The proceeds received are generally taxable to the policyholder. The portion of the payout equal to the policyholder’s cost basis (premiums paid) is received tax-free. Any amount received above the cost basis is generally taxable, with different portions potentially taxed as ordinary income or capital gains. Viatical settlements are typically exempt from federal income tax if the insured is certified as terminally ill.

Initiating a Policy Value Access Request

Once a policyholder determines the most suitable method for accessing their life insurance cash value, the next step involves direct interaction with the insurance company. Gathering essential policy information, including policy number and personal identification, is necessary for verification.

The primary way to initiate a request is by contacting the insurer directly, typically through their customer service line, official website, or a licensed insurance agent. During this contact, clearly state the desired action, whether it is a policy surrender, a loan, a partial withdrawal, or an inquiry about accelerated death benefits or life settlements. The insurer will then guide the policyholder through their specific procedural requirements.

For most transactions, the insurance company will require specific forms to be completed. For instance, a surrender requires a surrender request form, while a loan or withdrawal needs a corresponding loan or partial withdrawal form. These forms can often be downloaded from the insurer’s website or mailed directly to the policyholder. They typically ask for details such as the requested amount, desired payment method, and confirmation of understanding the implications.

After completing and signing the necessary forms, along with providing any required supporting documentation, the submission process can proceed. Insurers usually accept submissions via mail, fax, or secure online portals. Processing times can vary depending on the complexity of the request and the insurer’s internal procedures, generally ranging from a few business days for simple transactions like policy loans to several weeks for surrenders or settlements.