How to Cash In a Life Insurance Policy

When individuals need to access accumulated funds, they sometimes consider their life insurance policy. “Cashing in” a life insurance policy refers to the process of accessing the accumulated cash value within certain types of policies. Policyholders often explore this option when facing unexpected financial needs, seeking to supplement retirement income, or when the original purpose of the coverage is no longer applicable.

Understanding Policies with Cash Value

Cash value in a life insurance policy represents a component that grows over time, separate from the death benefit. This accumulated value can be accessed by the policyholder during their lifetime. The growth of this cash value is typically tax-deferred, meaning that taxes on the earnings are not due until the money is withdrawn or the policy is surrendered.

Certain types of permanent life insurance policies are designed to build cash value. Whole life insurance, for instance, offers a guaranteed cash value accumulation rate and a fixed premium. Universal life insurance provides more flexibility, allowing adjustments to premiums and death benefits while accumulating cash value based on an interest rate. Variable universal life policies also accumulate cash value, which is invested in sub-accounts chosen by the policyholder, offering potential for higher returns but also greater risk.

Not all life insurance policies accumulate cash value. Term life insurance, designed to provide coverage for a specific period, does not build any cash value. Consequently, term policies cannot be “cashed in” because there is no accumulated fund for the policyholder to access during the policy term. The ability to access funds is a defining characteristic of permanent life insurance products.

Methods for Accessing Policy Value

Policyholders have several distinct methods available to access the cash value within an eligible life insurance policy. One common approach is a policy surrender, which involves terminating the entire insurance contract. When a policy is surrendered, the insurer pays the policyholder the accumulated cash value, minus any outstanding loans or surrender charges, and the insurance coverage ceases completely. This option provides a lump sum but ends the death benefit protection.

Another method is taking a policy loan, where the policyholder borrows against the cash value of the policy. The loan amount is typically limited to a percentage of the policy’s cash value, and the policy remains in force. Policy loans accrue interest, and if the loan and accumulated interest are not repaid, they will reduce the death benefit paid to beneficiaries upon the insured’s passing. The policy can lapse if the outstanding loan plus interest grows to exceed the available cash value.

A third option is a partial withdrawal, which allows the policyholder to take out a portion of the cash value without terminating the policy. Unlike a loan, a withdrawal reduces the policy’s cash value and typically the death benefit directly by the amount withdrawn. Withdrawals generally do not need to be repaid, and they do not accrue interest like a loan. However, withdrawing too much cash value can weaken the policy’s financial stability and potentially lead to a lapse if premiums are no longer sufficient to cover policy charges.

Navigating the Access Process

Initiating the process to access your policy’s cash value typically begins with contacting your life insurance provider. You can reach out to their customer service department via phone, their official website, or through your assigned insurance agent. The insurer will confirm your policy’s eligibility and provide the necessary forms for your chosen method of access. It is important to specify whether you intend to surrender the policy, take a loan, or make a partial withdrawal, as each option requires specific documentation.

For a policy surrender, you will generally need to complete a surrender request form. This form typically asks for your policy number, personal identification information, the desired method of receiving funds (e.g., check or direct deposit), and a clear statement of your intent to surrender the policy. Similarly, for a policy loan, you will complete a loan application form, specifying the requested loan amount and acknowledging the terms, including the interest rate. Partial withdrawals require a withdrawal request form, detailing the amount you wish to withdraw.

Once you have completed the required forms, they must be submitted to the insurance company. This can often be done by mail, through a secure online portal on the insurer’s website, or sometimes in person at a local office. After submission, the insurance company will process the request, which typically takes between 7 to 14 business days, though processing times can vary based on the insurer and the complexity of the request.

Upon successful processing, the funds will be disbursed according to the method you selected on the form. This could be a physical check mailed to your address or a direct deposit into your specified bank account. The insurer will also provide a confirmation statement detailing the transaction, including any reductions to the death benefit, outstanding loan balances, or the termination of the policy itself.

Financial and Tax Implications

Accessing the cash value of a life insurance policy carries financial and tax implications. When you surrender a policy or make a withdrawal, any amount received that exceeds the total premiums paid into the policy, known as the cost basis, is considered a taxable gain. This taxable gain is taxed as ordinary income under Internal Revenue Code Section 72. For instance, if you paid $50,000 in premiums and received $65,000 upon surrender, the $15,000 difference would be taxable gain.

Surrender charges can also reduce the payout received when surrendering a policy, particularly in the early years of the policy’s life. These charges are fees imposed by the insurer to recover expenses associated with issuing the policy, such as commissions and administrative costs. Surrender charge schedules typically decline over time, often disappearing after 10 to 15 years, meaning that surrendering a policy early can result in a substantially lower net payout than the accumulated cash value.

The method of accessing cash value also impacts the policy’s death benefit. A complete policy surrender eliminates the death benefit entirely, as the contract is terminated. Policy loans and partial withdrawals, while allowing the policy to remain in force, will reduce the death benefit available to your beneficiaries. The outstanding loan balance, plus any accrued interest, is subtracted from the death benefit upon the insured’s death. Similarly, a partial withdrawal directly reduces the death benefit by the amount withdrawn.

Policy loans, unlike withdrawals, accrue interest, which must be repaid to prevent the loan balance from growing. If the loan and its accrued interest are not repaid, they will continue to reduce the policy’s cash value. If the outstanding loan plus interest eventually exceeds the policy’s cash value, the policy can lapse, potentially triggering a taxable event where any gains on the policy become immediately taxable. Therefore, managing policy loans is important to maintain the intended policy benefits and avoid unintended tax consequences.

Financial and Tax Implications

Accessing the cash value of a life insurance policy carries financial and tax implications. When you surrender a policy or make a withdrawal, any amount received that exceeds the total premiums paid into the policy, known as the cost basis, is considered a taxable gain. This taxable gain is taxed as ordinary income under Internal Revenue Code Section 72. For instance, if you paid $50,000 in premiums and received $65,000 upon surrender, the $15,000 difference would be taxable gain.

Surrender charges can also reduce the payout received when surrendering a policy, particularly in the early years of the policy’s life. These charges are fees imposed by the insurer to recover expenses associated with issuing the policy, such as commissions and administrative costs. Surrender charge schedules typically decline over time, often disappearing after 10 to 15 years, meaning that surrendering a policy early can result in a substantially lower net payout than the accumulated cash value.

The method of accessing cash value also impacts the policy’s death benefit. A complete policy surrender eliminates the death benefit entirely, as the contract is terminated. Policy loans and partial withdrawals, while allowing the policy to remain in force, will reduce the death benefit available to your beneficiaries. The outstanding loan balance, plus any accrued interest, is subtracted from the death benefit upon the insured’s death. Similarly, a partial withdrawal directly reduces the death benefit by the amount withdrawn.

Policy loans, unlike withdrawals, accrue interest, which must be repaid to prevent the loan balance from growing. If the loan and its accrued interest are not repaid, they will continue to reduce the policy’s cash value. If the outstanding loan plus interest eventually exceeds the policy’s cash value, the policy can lapse, potentially triggering a taxable event where any gains on the policy become immediately taxable. Therefore, managing policy loans is important to maintain the intended policy benefits and avoid unintended tax consequences.