Can You Cash Out on Term Life Insurance?

Life insurance provides a financial safeguard, offering a death benefit to beneficiaries upon the insured’s passing. Term life insurance is often chosen for its affordability and straightforward nature. However, a common question arises regarding its financial flexibility: can term life insurance policies be “cashed out” like some other financial assets?

Understanding Term Life Insurance

Term life insurance provides coverage for a specific period, or “term,” typically 10 to 30 years. It pays a death benefit if the insured passes away during this term. The premiums paid for a term life policy are allocated directly to cover the cost of the insurance coverage and administrative expenses.

Unlike other forms of life insurance, term life policies do not accumulate a cash value or investment component. When the policy term ends, if the insured is still alive, the coverage typically ceases with no payout or accumulated funds returned to the policyholder. While some term policies may offer a “return of premium” rider, this feature comes at a higher cost and is not standard.

Distinguishing Term from Permanent Life Insurance

The fundamental difference between term and permanent life insurance lies in the presence or absence of a cash value component. Permanent life insurance policies, such as whole life or universal life, include a savings or investment element that grows over time. A portion of each premium payment for these policies is directed towards building this cash value, which accumulates on a tax-deferred basis.

Policyholders with permanent life insurance can access this cash value during their lifetime. They may take withdrawals, secure loans against it, or surrender the policy for its cash value. Surrendering terminates coverage and may incur taxes on gains. These options provide financial liquidity that is not inherent in term life insurance due to its pure protection design.

Alternative Options for Term Life Policyholders

While term life insurance does not allow for “cashing out” a built-in cash value, limited circumstances exist where a policyholder might access funds or transfer their policy. One such option is an Accelerated Death Benefit (ADB) rider, also known as a living benefits rider. This feature, if included in the policy, allows an insured individual to receive a portion of their death benefit early if diagnosed with a terminal or chronic illness. These funds are an advance on the death benefit, reducing the amount paid to beneficiaries later. Accelerated death benefits are generally excluded from gross income for federal tax purposes if the insured is terminally or chronically ill.

Another alternative is a life settlement or viatical settlement, which involves selling the life insurance policy to a third-party investor. In a viatical settlement, for individuals who are terminally or chronically ill, the policyholder receives a lump sum cash payment. This amount is less than the full death benefit but more than the policy’s cash surrender value, which is zero for term life policies. The investor then assumes responsibility for future premium payments and receives the full death benefit upon the insured’s passing. For tax purposes, proceeds from a life settlement up to the total premiums paid are typically tax-free; any amount exceeding this is generally taxed as ordinary income or capital gains.