How to Cash Out a Life Insurance Policy

Certain life insurance policies accumulate a cash value that policyholders can access during their lifetime. This guide explains how to access your policy’s cash value and the financial and tax implications involved.

Understanding Cash Value Life Insurance

Cash value life insurance policies provide a death benefit while building a savings component. This cash value grows on a tax-deferred basis, with earnings taxed only upon withdrawal or surrender. A portion of each premium contributes to this cash value, distinct from the cost of insurance and administrative fees.

Several types of life insurance policies accumulate cash value. Whole life insurance, for instance, offers a guaranteed cash value growth rate and a level premium for the life of the policy. Universal life insurance provides more flexibility, allowing policyholders to adjust premiums and death benefits, and its cash value growth often depends on interest rates.

Variable universal life insurance further introduces investment options, allowing the cash value to grow based on the performance of underlying investment sub-accounts, though this also carries investment risk. These policies contrast with term life insurance, which provides coverage for a specific period and does not build any cash value.

Methods for Accessing Policy Cash Value

Policyholders have several methods to access the cash value accumulated within their life insurance policy. Each method has unique implications for the policy and its beneficiaries, affecting continued coverage and future benefits.

A common method is policy surrender, terminating the life insurance contract. The policyholder receives the cash surrender value, which is the accumulated cash value minus any outstanding loans or surrender charges. Surrender charges are fees applied if the policy is surrendered within a certain period, often the first 10 to 15 years.

Policy loans allow access to cash value without terminating coverage. A policyholder can borrow funds directly from the insurance company, with the policy’s cash value serving as collateral. The policy remains in force, and interest accrues on the borrowed amount, typically at a variable or fixed rate. Any outstanding loan balance, including accrued interest, will reduce the death benefit paid to beneficiaries if the insured passes away before the loan is fully repaid.

Some cash value policies also permit partial withdrawals, allowing the policyholder to take out a portion of the accumulated cash value directly. Unlike a loan, a withdrawal permanently reduces the policy’s cash value and, consequently, the death benefit amount. The policy remains in force after a partial withdrawal, but with reduced future values and coverage.

Financial and Tax Implications

Accessing the cash value of a life insurance policy carries significant financial and tax implications. Each method of accessing funds has different consequences for the policy’s value, its death benefit, and potential tax liabilities.

Surrender charges are fees deducted from the cash value when a policy is terminated. The surrender charge schedule is outlined in the policy contract, often decreasing over time and usually disappearing after 10 to 15 years.

The taxation of withdrawals and surrenders from a cash value life insurance policy is governed by specific rules. Generally, amounts withdrawn or received upon surrender up to the policy’s “cost basis” are considered a return of premiums paid and are not subject to income tax. The cost basis represents the total premiums paid into the policy, less any prior tax-free withdrawals. However, any amount received that exceeds this cost basis is typically taxable as ordinary income, not capital gains.

Policy loans are generally not considered taxable income as long as the policy remains in force. This tax-free treatment is a significant advantage, allowing policyholders to access funds without immediate tax consequences. However, if the policy lapses or is surrendered with an outstanding loan, the loan amount exceeding the cost basis can become taxable income. This situation, often referred to as a “taxable lapse,” can result in an unexpected tax bill for the policyholder.

Each method of accessing cash value also impacts the policy’s death benefit. A full policy surrender eliminates the death benefit entirely, as the policy ceases to exist. Partial withdrawals directly reduce the death benefit by the amount withdrawn, as both the cash value and the death benefit are decreased. Similarly, any outstanding policy loan, including accrued interest, will be subtracted from the death benefit paid to beneficiaries upon the insured’s death.

Initiating Your Cash Value Request

To initiate a cash value request, contact your life insurance provider directly. You can usually reach them through their customer service phone number, an online policyholder portal, or by contacting your appointed insurance agent.

When you contact the insurer, they will require specific information to process your request. Be prepared to provide your full policy number. You will also need to verify your identity, providing personal information like your full name, date of birth, and potentially the last four digits of your Social Security number. For direct deposit, provide your banking information, including bank name, routing number, and account number.

The insurance company will then provide the necessary forms specific to your chosen transaction, whether it’s a surrender form, a policy loan request form, or a partial withdrawal form. These forms can often be downloaded from the insurer’s website, or they can be mailed to you. It is important to carefully and accurately complete all required fields on these forms, ensuring that all information provided matches your policy records and personal identification.

After completing the forms, you will need to submit them along with any required supporting documentation. Common submission methods include mailing the original signed forms, faxing them to a dedicated number, or uploading scanned copies through a secure online portal. Always retain copies of all submitted documents for your records.

Upon submission, the insurer will process your request, which typically takes anywhere from a few business days to a few weeks, depending on the complexity of the transaction and the company’s processing times. You should receive a confirmation once your request has been processed. Funds are usually disbursed via direct deposit or a physical check mailed to your address on file.