Can You Cash Out a Term Life Insurance Policy?

Life insurance provides financial support to beneficiaries upon the policyholder’s passing. Term life insurance generally does not build cash value, unlike other forms of life insurance with a savings component. This means it cannot be “cashed out” in the traditional sense.

Understanding Term Life Insurance

Term life insurance provides a death benefit for a specific period, known as the “term,” typically ranging from 10 to 30 years. This policy type is often called “pure protection” because premiums primarily cover the death benefit, without contributing to an investment or savings component. The absence of cash value means term life insurance typically has lower premiums compared to permanent policies offering comparable coverage.

When the term concludes, the policy generally expires, and coverage ceases. Policyholders may renew coverage, though this often comes at a significantly higher premium due to increased age. Some term policies also include a conversion privilege, allowing a switch to a permanent life insurance policy, usually without a new medical examination.

Distinguishing Permanent Life Insurance

Unlike term life insurance, permanent life insurance policies, such as whole life or universal life, provide coverage for the policyholder’s entire lifetime. A defining feature is their ability to accumulate cash value over time. A portion of each premium contributes to this cash value, which grows on a tax-deferred basis. This means taxes on accumulated earnings are postponed until funds are withdrawn or the policy is surrendered.

Policyholders can access the accumulated cash value while living through various methods:

• Taking a policy loan, using the cash value as collateral. These loans are generally not considered taxable income, provided the policy remains in force and the loan is repaid.
• Making partial withdrawals from the cash value, which are typically tax-free up to the amount of premiums paid. Any amount withdrawn beyond total premiums paid is usually subject to income tax.
• Surrendering the policy entirely for its cash surrender value, which is the accumulated cash value minus any applicable surrender charges. If the cash surrender value exceeds total premiums paid, the excess amount is generally taxable as ordinary income.

What to Do with a Term Life Policy

Since term life policies do not accumulate cash value, they cannot be “cashed out” like permanent policies. If a policyholder’s needs change or coverage is no longer required, several options are available. One option is to let the policy lapse by discontinuing premium payments. This results in the termination of coverage, and no payout is made to the policyholder.

Another option, if the policy allows, is to convert it to a permanent life insurance policy. Many term policies offer a conversion privilege, allowing this transition without a new medical exam, often within a specific timeframe or before a certain age. Converting enables the policy to begin accumulating cash value and provides lifelong coverage, though premiums for the new permanent policy will be higher.

In specific circumstances, such as for seniors or individuals facing a serious illness, it may be possible to sell the death benefit of a term policy through a life settlement or viatical settlement. A life settlement involves selling the policy to a third-party investor for an amount greater than its cash surrender value (if any) but less than the full death benefit. For term policies, where there is no cash value, the proceeds from a life settlement are typically taxed as a capital gain, after accounting for premiums paid.

A viatical settlement is a specific type of life settlement for terminally ill policyholders, and proceeds may be exempt from taxation under certain conditions. These settlements are distinct from “cashing out” an inherent policy value, as they involve selling the future death benefit to an external party.