Can You Cash Out on Your Life Insurance?

“Cashing out” life insurance means a policyholder accesses money accumulated within their policy while still alive. Not all policies build cash value, so not all can be “cashed out.” This article clarifies which policies offer this feature and the mechanisms for accessing funds, along with financial and policy considerations.

Types of Life Insurance and Cash Value

Life insurance policies fall into two main categories: term life and permanent life. Term life insurance provides coverage for a specific period, typically 10, 20, or 30 years. This policy does not build cash value and is solely for a death benefit if the insured passes away within the term.

Permanent life insurance policies provide coverage for the policyholder’s entire life. These policies include a savings or investment component called “cash value.” Whole life, universal life, and variable universal life are examples of permanent policies that accumulate cash value. This cash value is distinct from the death benefit and is an asset the policyholder can access.

Cash value grows through premiums, interest earnings, or investment returns, depending on policy type. Whole life policies often grow at a guaranteed rate and may be eligible for dividends. Universal life policies offer flexibility in premium payments and death benefits, with cash value growth tied to an insurer-set interest rate. Variable universal life policies allow policyholders to direct the cash value into various investment sub-accounts, meaning its growth fluctuates with market performance.

The rate at which cash value accumulates and rules for accessing it vary by policy type and insurance carrier. Cash value represents a living benefit that can be used for various financial needs while the insured is alive, offering flexibility beyond the death benefit.

Methods of Accessing Cash Value

Policyholders with permanent life insurance can access their accumulated cash value through several methods. Each approach impacts the policy’s cash value and death benefit differently.

Policy Loan

A policy loan involves borrowing money from the insurance company using the policy’s cash value as collateral. The cash value itself is not directly removed from the policy; instead, it continues to grow, and the insurer lends funds against it. Interest accrues on the loan, typically between 4% and 8%. The loan reduces the death benefit payable to beneficiaries if it is not repaid before the policyholder’s death. Repayment terms are flexible, allowing policyholders to repay at their own pace or not at all, though interest continues to accrue.

Cash Withdrawal

A cash withdrawal, or partial surrender, involves directly removing a portion of the accumulated cash value from the policy. This permanently reduces both the policy’s cash value and the death benefit. For example, if a policy has a $10,000 cash value and a policyholder withdraws $2,000, the cash value decreases to $8,000, and the death benefit is also reduced, often by the amount withdrawn or more, depending on policy terms. Withdrawals are generally tax-free up to the amount of premiums paid into the policy, which is known as the cost basis.

Full Policy Surrender

A full policy surrender means completely terminating the life insurance policy. When a policy is surrendered, the policyholder receives the “cash surrender value,” which is the policy’s cash value minus any applicable surrender charges and outstanding loans. Surrender charges are fees imposed by the insurer for early termination, particularly within the first 10 to 15 years of the policy. Upon full surrender, the policy ceases to exist, and the death benefit is entirely forfeited.

Financial and Policy Implications of Accessing Cash Value

Accessing cash value within a life insurance policy carries significant financial and policy-related consequences. These implications affect taxation, the death benefit, and the policy’s long-term viability.

Tax Implications

Tax implications are a primary consideration when accessing cash value. Cash withdrawals and policy surrenders are generally tax-free up to the “cost basis,” which is the total amount of premiums paid. Any amount received above this cost basis is typically taxable income. For instance, if a policyholder has paid $50,000 in premiums and receives $60,000, the $10,000 gain would likely be taxable.

Policy loans are generally tax-free. However, if a policy lapses or is surrendered with an outstanding loan exceeding the cost basis, the outstanding loan balance can become taxable. This is particularly true for policies classified as Modified Endowment Contracts (MECs), where all withdrawals and loans are taxed on a “last-in, first-out” (LIFO) basis, meaning gains are considered withdrawn first and are subject to income tax and potentially a 10% penalty if the policyholder is under age 59½.

Impact on Death Benefit

The impact on the death benefit is an important consequence. Outstanding policy loans directly reduce the death benefit payable to beneficiaries. For example, a $20,000 outstanding loan on a $100,000 death benefit policy would result in beneficiaries receiving only $80,000 upon the insured’s death. Cash withdrawals also directly reduce the death benefit, as money is permanently removed from the policy. A full policy surrender eliminates the death benefit entirely, as the policy ceases to exist.

Risk of Policy Lapse

Accessing cash value can also introduce a risk of policy lapse. Significant loans or withdrawals can deplete the cash value to a point where it becomes insufficient to cover the policy’s ongoing charges, such as the cost of insurance and administrative fees. If the cash value falls below the amount needed to sustain the policy, and no additional premiums are paid, the policy could lapse, resulting in the loss of coverage.

Future Premium Obligations

Finally, accessing cash value might affect future premium obligations. While some policies are designed to become “paid-up” after a certain period, meaning the cash value can cover future premiums, a substantial reduction in cash value from loans or withdrawals could necessitate continued premium payments to keep the policy in force. Policyholders should monitor their policy’s performance and cash value closely, especially after accessing funds, to ensure it remains adequately funded to avoid an unintentional lapse.