How to Cash Out a Life Insurance Policy

“Cashing out” a life insurance policy means accessing its accumulated financial value during the insured’s lifetime. This option is available with certain life insurance types that build a cash component over time.

Understanding Policy Value

Life insurance policies that allow “cashing out” feature “cash value.” This value accumulates over time from a portion of premium payments, growing tax-deferred. Part of premiums covers insurance costs and fees, while another part is allocated to this savings component, which may earn interest or investment returns. The accumulation rate varies by policy type, with some offering guaranteed growth and others tying growth to market performance.

“Surrender value” is the net amount a policyholder receives if they terminate their policy. It’s calculated by taking the accumulated cash value and subtracting any surrender charges, outstanding policy loans, or other fees. Surrender charges are higher initially and decrease over time, sometimes disappearing after 10 to 15 years. Term life insurance policies do not build cash value. Permanent life insurance policies like whole life, universal life, variable life, and indexed universal life are designed to accumulate cash value.

Methods to Access Policy Value

Policy Surrender

Policy surrender involves formally terminating the life insurance contract. The policyholder receives the cash surrender value, and insurance coverage ceases.

Policy Loan

A policy loan allows borrowing money from the insurer, using the policy’s cash value as collateral. The policy remains in force, and the loan accrues interest. Any outstanding loan balance, including accrued interest, reduces the death benefit paid to beneficiaries if the insured passes away before repayment. Most insurers allow borrowing up to around 90% of the policy’s cash value.

Life Settlement

A life settlement involves selling an existing life insurance policy to a third-party investor for a lump sum. This payment is typically more than the cash surrender value but less than the full death benefit. The investor becomes the new policy owner, assumes future premium payments, and receives the death benefit upon the insured’s passing. This option is generally available for policyholders at least 65 years old with a policy death benefit of at least $100,000, or those with a change in health.

Accelerated Death Benefits (ADB)

ADB, also known as living benefits, are provisions allowing a policyholder to access a portion of their death benefit while still alive. These benefits are available under specific qualifying circumstances, such as a diagnosis of terminal illness with limited life expectancy, chronic illness requiring long-term care, or critical illness. Accessing ADB reduces the eventual death benefit paid to beneficiaries. The amount accessible varies, with some insurers allowing access to 25% to 100% of the death benefit.

Tax Considerations

Tax implications depend on the access method. When surrendering a policy, if the amount received exceeds total premiums paid (cost basis), the excess is generally taxable as ordinary income. If the surrender value is less than or equal to premiums paid, there is no taxable gain.

Policy loans are typically tax-free as long as the policy remains in force. If the policy lapses or is surrendered with an outstanding loan, the loan amount exceeding the cost basis can become taxable.

For life settlements, proceeds are generally subject to tiered taxation. The portion up to the cost basis is typically tax-free. Any amount exceeding the cost basis but less than the cash surrender value may be taxed as ordinary income. Any amount received above the cash surrender value is often taxed as a capital gain.

Accelerated Death Benefits are generally tax-free under current IRS rules, provided the insured is certified as terminally or chronically ill and certain conditions are met. This applies if the payout is used for qualifying medical expenses or long-term care. IRS Publication 525 provides further guidance.

Initiating a Transaction

To initiate a transaction, contact the insurance company’s customer service or policy services department, often by phone or online portal.

The insurer will provide necessary forms for the chosen transaction, such as a surrender request, loan application, or paperwork for accelerated death benefits or life settlements. Required documentation may include the policy number, proof of identity, and medical statements for health-related requests.

Policyholders must accurately complete these forms. Submission methods include mail, online portals, or fax. Processing times vary; surrenders or loans may disburse funds within days to weeks. Life settlements and accelerated death benefits may take several weeks to months due to medical underwriting and extensive review. After submission, expect confirmation and details regarding fund disbursement or request status.