How to Cash Out a Life Insurance Policy

When considering a life insurance policy, many people focus on the death benefit it provides to beneficiaries. However, certain types of life insurance policies can accumulate a “cash value” over time. This accumulated value represents a living benefit that policyholders may be able to access during their lifetime, offering financial flexibility.

Understanding Life Insurance Cash Value

Cash value in a life insurance policy refers to a savings component that grows over time. A portion of each premium payment is allocated to this cash value account, which then accumulates interest or earns returns, often on a tax-deferred basis. This accumulated value is distinct from the death benefit, which is the amount paid to beneficiaries upon the insured’s passing.

Only permanent life insurance policies, such as whole life, universal life, variable life, and indexed universal life, build cash value. Term life insurance policies do not accumulate cash value. The growth rate of the cash value can vary by policy type; for instance, whole life policies typically offer a fixed interest rate, while universal life policies may have a guaranteed minimum rate but can fluctuate based on market conditions.

Surrendering Your Life Insurance Policy

One way to access the cash value is by surrendering the policy, which means terminating the contract in exchange for its cash surrender value. This action ends the life insurance coverage, and no death benefit will be paid to beneficiaries. The cash surrender value is generally the accumulated cash value minus any outstanding loans, withdrawals, and applicable surrender charges. Surrender charges are fees that insurers may impose, especially in the early years of a policy, and they can significantly reduce the amount received.

To surrender a policy, you typically contact your insurance provider to request the necessary forms. You will need to provide specific information, such as your policy number and personal identification, to verify your ownership. After completing and submitting the surrender form, the insurer processes the request, and funds are usually disbursed within a few weeks.

From a tax perspective, the cash surrender value received is generally not taxable up to the amount of total premiums paid into the policy, which is considered your cost basis. However, any amount received that exceeds this cost basis is considered a taxable gain and may be subject to ordinary income tax rates. If there are outstanding policy loans that exceed the policy’s cost basis, these amounts can also become taxable upon surrender.

Taking a Loan Against Your Life Insurance Policy

Policyholders can also access their cash value by taking a loan against it. This is not a withdrawal of funds but rather a loan from the insurer, using the policy’s cash value as collateral. The policy remains in force, and coverage continues, though an outstanding loan will reduce the death benefit payable to beneficiaries if not repaid.

To initiate a policy loan, contact your insurance company and request a loan application. Most policies allow borrowing up to a certain percentage, often around 90%, of the accumulated cash value. Unlike traditional loans, policy loans typically do not require credit checks or have strict repayment schedules.

Interest accrues on the outstanding loan balance, and this interest can be paid regularly or allowed to accumulate, further reducing the death benefit. While repayment is flexible, if the loan balance plus accrued interest grows to exceed the policy’s cash value, the policy may lapse. If a policy lapses with an outstanding loan, the loan amount that exceeds the premiums paid can become taxable income. Its tax-free status depends on the policy remaining in force.

Selling Your Life Insurance Policy

Selling a life insurance policy involves transferring ownership to a third party in exchange for a cash payment. This payment is typically more than the policy’s cash surrender value but less than the full death benefit. This option allows policyholders to gain access to a larger portion of their policy’s value than a surrender might provide, particularly for older or less healthy individuals.

There are two primary types of policy sales: life settlements and viatical settlements. A life settlement involves selling a policy to a third party, usually for policyholders who are generally aged 65 or older, or those with significant health changes, but who are not terminally ill. A viatical settlement is specifically for policyholders with a terminal illness, typically with a life expectancy of 24 months or less, or a chronic illness. Eligibility for these settlements often requires a review of medical records and policy details.

The process of selling a policy usually involves working with a licensed life settlement broker or provider who facilitates offers from various buyers. Medical underwriting is a key step, as it helps determine the policy’s value and the offer amount. After an offer is accepted, ownership of the policy is transferred to the buyer, who then becomes responsible for future premium payments and receives the death benefit when the insured passes away.

The tax implications of selling a policy differ based on the type of settlement. For life settlements, the proceeds are generally taxed in tiers: the portion up to the policy’s cost basis (premiums paid) is tax-free. The amount received above the cost basis, up to the policy’s cash surrender value, is taxed as ordinary income. Any remaining proceeds are taxed as capital gains. For viatical settlements, amounts received by a terminally or chronically ill individual are generally tax-free under Internal Revenue Code Section 101, provided certain conditions are met.