How to Cash In the Value of a Life Insurance Policy

Cashing in the value of a life insurance policy refers to accessing accumulated cash reserves within certain types of policies while the policyholder is living. This differs from receiving the death benefit, which is paid to beneficiaries upon the policyholder’s passing. This option allows individuals to utilize a financial asset that has grown over time, potentially providing funds for various needs. Only specific types of life insurance policies are designed with this cash value component.

Policies with Cash Value

Cash value in a life insurance policy represents a savings component that accumulates over time, distinct from the death benefit. A portion of each premium payment contributes to this cash value, which then grows through guaranteed interest, market performance, or dividends, depending on the policy type. This accumulated cash becomes a financial asset accessible during the policyholder’s lifetime.

Permanent life insurance policies build cash value. Whole life insurance offers a fixed premium and a cash value that grows at a guaranteed interest rate. Universal life insurance provides more flexibility, allowing adjustments to premiums and death benefits, with its cash value growing based on current interest rates or market performance. Variable universal life insurance offers investment flexibility, permitting policyholders to invest the cash value in various subaccounts, similar to mutual funds, where growth depends on investment performance but also carries market risk. Term life insurance policies provide coverage for a specific period and do not accumulate cash value.

Accessing Cash Value

Policyholders have several methods for accessing the cash value accumulated within their life insurance policies. Each method impacts the policy’s status and benefits. Understanding these differences is important for informed decisions.

Surrendering a policy involves terminating life insurance coverage in exchange for its cash surrender value. This value is the accumulated cash value minus any applicable surrender charges and outstanding loans. When a policy is surrendered, all coverage ceases, and the death benefit is forfeited. Surrender charges are typically higher in early years and may decrease or disappear after 10 to 15 years. The policyholder receives the cash surrender value as a lump sum payment.

A policy loan allows the policyholder to borrow money from the insurer, using the policy’s cash value as collateral. The policy remains in force, and coverage continues as long as premiums are paid and the loan balance does not exceed the cash value. Interest accrues on the loan, typically ranging from 5% to 8%. While there is no strict repayment schedule, any outstanding loan balance, including accrued interest, will reduce the death benefit. If the loan plus interest grows to exceed the cash value, the policy could lapse, leading to loss of coverage.

Partial withdrawals involve taking out a portion of the policy’s cash value. Unlike a loan, a withdrawal reduces the cash value dollar-for-dollar and typically also reduces the death benefit. The policy generally remains in force after a partial withdrawal, preserving some level of coverage. Some policies may have waiting periods, such as one to two years, before withdrawals are permitted, and limits on the amount that can be withdrawn, often a percentage of the fund value.

Tax Implications of Accessing Funds

The tax consequences of accessing a life insurance policy’s cash value depend on the method chosen. Understanding these implications is important for financial planning.

When a policy is surrendered, the amount received that exceeds the “cost basis” is generally considered taxable income. The cost basis refers to the total premiums paid into the policy, less any previous tax-free withdrawals. Any amount received above this cost basis is taxed as ordinary income.

Policy loans are generally tax-free as long as the policy remains in force. The borrowed funds are considered a loan against the policy’s cash value, not income. However, if the policy lapses or is surrendered with an outstanding loan, the untaxed portion of the loan may become taxable income, especially if the loan balance exceeds the policy’s cost basis.

Partial withdrawals are typically treated on a “first-in, first-out” (FIFO) basis for tax purposes. This means withdrawals are considered a return of the premiums paid (cost basis) first, which is generally tax-free. Once total withdrawals exceed the cost basis, any subsequent amounts are considered taxable gains. Consulting with a qualified tax advisor is recommended before accessing policy funds.

The Process of Requesting Funds

Initiating a request to access your life insurance policy’s cash value involves administrative steps. The process typically begins with contacting your life insurance provider directly, via their customer service phone line, an online portal, or by mail.

During this initial contact, the insurer will guide you on the requirements and forms needed for your chosen method of access (surrender, loan, or partial withdrawal). You will typically need to provide your policy number and proof of identity. For a policy surrender, the insurer may require the original policy document, a voided check for direct deposit, and Know Your Customer (KYC) documents.

Once you have the necessary forms, complete them with all requested information. These forms detail the specific amount you wish to access and your preferred disbursement method. After completion, submit the forms, along with any required supporting documentation, to the insurance company. Submission methods include mailing physical documents or uploading them through the insurer’s secure online platform.

After submission, the insurance company will process your request. Processing time varies depending on the chosen method of access and the insurer’s internal procedures. Partial withdrawals and policy loans are often processed quickly, typically within a few business days to a couple of weeks. Policy surrenders may take longer, often two to six weeks, as the company calculates the final cash surrender value after deductions. Funds are then disbursed via direct deposit or mailed check.