How to Cash In Your Life Insurance Policy

Life insurance policies can offer more than just a death benefit for beneficiaries. Certain types of policies accumulate a cash value component that policyholders may access during their lifetime. This accumulated value can serve as a financial resource, providing flexibility for various needs. This article explores how policyholders can access this value, outlining the processes and considerations.

Methods for Accessing Policy Value

Policyholders have several distinct methods to access the value built within their permanent life insurance.

A common approach is taking a policy loan, where the policyholder borrows money directly from the insurer, using the policy’s cash value as collateral. This type of loan does not require a credit check and typically accrues interest. The policy remains in force, and the loan does not have a fixed repayment schedule.

Another method involves a policy surrender, which means terminating the life insurance policy entirely. In exchange for cancellation, the insurer pays the policyholder the cash surrender value. This action results in the forfeiture of the policy’s death benefit, and surrender charges may apply, particularly if the policy is relatively new.

Policyholders may also consider a life settlement, which involves selling the life insurance policy to a third-party company for a lump sum. This amount is generally more than the policy’s cash surrender value but less than the full death benefit. Life settlements are typically an option for individuals aged 65 or older who are generally healthy.

A viatical settlement is a specialized type of life settlement designed for individuals with a terminal or chronic illness. The policy is sold to a third party for a lump sum. The amount received is typically greater than the cash surrender value but less than the death benefit, providing financial relief during a challenging time.

Understanding Your Policy’s Cash Value

Cash value represents a savings component integrated within specific types of permanent life insurance policies. This portion grows tax-deferred and functions as an accessible fund while coverage remains active.

Not all life insurance policies build cash value. Term life insurance provides coverage for a specific period and does not accumulate any cash value. Permanent life insurance policies are designed to last for the policyholder’s entire life and typically include a cash value component.

Common types of permanent policies that build cash value include whole life, universal life, variable universal life, and indexed universal life. In whole life policies, cash value often grows at a guaranteed fixed rate. For universal life policies, growth is based on interest credits, while variable universal life and indexed universal life policies link cash value growth to investment performance or market indexes. A portion of each premium payment contributes to this cash value, with the remainder covering the cost of insurance and administrative fees.

To determine the current cash value of a policy, policyholders can review their annual statements from the insurance company. These statements detail both cash value and cash surrender value, which may differ due to surrender charges. Alternatively, contact the insurance provider directly via phone or their online portal for up-to-date information.

Initiating the Access Process

Accessing policy value involves specific procedural steps that vary by method. For policy loans and surrenders, the initial step is contacting the insurance company to obtain necessary forms and instructions.

For a policy loan, after contacting the insurer, the policyholder will receive a loan application form. This form requires basic policy information, such as the policy number and the desired loan amount, which will be within the available cash value. Once completed, the form is submitted to the insurance company, and upon approval, funds are disbursed, often within a few business days or weeks.

When surrendering a policy, the process begins by requesting a surrender form from the insurance company. This form will ask for details like the policy number, policyholder information, and confirmation of the intent to terminate coverage. After completing and submitting the form, the insurer processes the request and sends the cash surrender value, minus any applicable fees, to the policyholder. This process can take several weeks to finalize.

For life settlements and viatical settlements, the procedure involves working with a licensed life settlement broker or provider. The policyholder typically provides policy details and medical information to the broker, who then solicits offers from various third-party buyers. Once an offer is accepted, the policyholder completes an application, undergoes a medical underwriting review, and signs transfer documents. Policy ownership is then transferred, and the lump sum payment is disbursed to the policyholder. This entire process can range from several weeks to a few months.

Tax and Financial Considerations

Accessing a policy’s cash value has tax and financial implications that vary by method. Understanding these outcomes is important for financial planning.

Policy loans are generally not considered taxable income as long as the policy remains in force. The Internal Revenue Service (IRS) views these as borrowing against an asset, not as a distribution of income. However, if the policy lapses or is surrendered with an outstanding loan, the untaxed portion of the loan, up to the policy’s gain, may become taxable. Unpaid policy loans, including accrued interest, will reduce the death benefit paid to beneficiaries if the policyholder passes away before repayment.

When surrendering a policy, any amount received that exceeds the total premiums paid into the policy (your “cost basis”) is typically considered taxable income. This gain is taxed as ordinary income, not capital gains. Additionally, surrender charges, which can be substantial in the early years of a policy, will reduce the net amount received. Surrendering the policy eliminates the death benefit entirely, meaning beneficiaries will receive no payout upon the policyholder’s death.

Proceeds from a life settlement are taxed in a tiered manner. The amount received up to the policy’s cost basis (total premiums paid) is generally tax-free. Any amount above the cost basis, up to the policy’s cash surrender value, is taxed as ordinary income. Any remaining proceeds exceeding the cash surrender value are taxed as capital gains. A life settlement results in the transfer of policy ownership, meaning the original beneficiaries will no longer receive a death benefit.

Viatical settlements for terminally or chronically ill individuals are generally tax-free under federal law, provided specific IRS criteria are met. The insured must typically be certified by a physician as having a life expectancy of 24 months or less, or be chronically ill and unable to perform certain daily living activities. If the viatical settlement qualifies, the proceeds are treated as an advance on the death benefit. This allows the original beneficiaries to receive no payout from the policy as ownership has been transferred.