Is There Term Life Insurance You Can Cash Out?

Life insurance provides financial protection, paying funds to beneficiaries upon the insured’s death. While many policies offer a death benefit, term life insurance does not include a cash value component. Policies that allow for cash value accumulation are categorized as permanent life insurance.

Understanding Term Life Insurance

Term life insurance provides coverage for a specific period, known as the “term,” typically 10 to 30 years. If the insured passes away within this term, the policy pays a death benefit to beneficiaries. Designed for temporary financial protection, such as covering a mortgage or providing for dependents, term life insurance does not build cash value. Premiums primarily cover the cost of the death benefit. Its simplicity and focus on temporary coverage make it a more affordable option.

Understanding Permanent Life Insurance

In contrast to term life insurance, permanent life insurance policies provide coverage for an individual’s entire life, as long as premiums are paid. These policies feature a death benefit guaranteed to be paid to beneficiaries regardless of when the insured passes away. A distinguishing feature is a cash value component. This cash value is a savings element that accumulates over time. A portion of each premium is allocated to this account, where it grows on a tax-deferred basis. Earnings are not subject to income tax until withdrawn. This growth provides a living benefit.

Types of Permanent Life Insurance with Cash Value

Permanent life insurance encompasses several types, each with distinct features regarding how cash value accumulates.

Whole life insurance

Whole life insurance is a traditional form of permanent coverage known for its stability and guarantees. It provides a guaranteed death benefit, fixed premium payments, and cash value that grows at a guaranteed interest rate. This predictable growth ensures the cash value increases steadily over time. Some whole life policies may also earn dividends, which can be used to increase cash value, reduce premiums, or be taken as cash.

Universal life insurance (UL)

Universal life insurance (UL) offers more flexibility than whole life regarding premiums and death benefits. Policyholders can adjust premium payments within certain limits. Cash value growth is tied to an interest rate declared by the insurer, with a guaranteed minimum. This flexibility can allow policyholders to pay less into the policy if the cash value has accumulated sufficiently to cover the cost of insurance. However, cash value growth and the death benefit are not as strictly guaranteed as with whole life.

Variable universal life insurance (VUL)

Variable universal life insurance (VUL) combines permanent life insurance with an investment component. The cash value can be invested in various sub-accounts, similar to mutual funds, allowing for potential growth based on market performance. While VUL policies offer potential for higher returns, they also carry greater risk, as cash value can fluctuate with market conditions and may decrease if investments perform poorly. VUL also provides flexible premiums and death benefits, similar to universal life, but requires careful monitoring due to market exposure.

Indexed universal life insurance (IUL)

Indexed universal life insurance (IUL) is another variant of universal life where cash value growth is linked to a specific stock market index, such as the S&P 500. Unlike VUL, the cash value is not directly invested but credited interest based on the index’s performance. IUL policies include a floor, guaranteeing a minimum interest rate, and a cap, limiting the maximum interest rate credited, balancing growth potential with downside protection.

Accessing Policy Cash Value

The accumulated cash value in a permanent life insurance policy can be accessed by the policyholder through several methods. Each method has distinct implications for the policy’s death benefit and potential tax consequences.

Policy surrender

Policy surrender occurs when the policyholder terminates the life insurance contract. Upon surrender, the policyholder receives the accumulated cash surrender value, which is the cash value minus any surrender charges or outstanding loans. If the amount received exceeds the total premiums paid (cost basis), the excess is considered taxable income and taxed at ordinary income rates.

Policy loans

Policy loans allow policyholders to borrow money against their accumulated cash value, using it as collateral. These loans are not considered taxable income, as they are treated as a debt against the policy. Interest is charged on policy loans, and if the loan and accrued interest are not repaid, they will reduce the death benefit paid to beneficiaries.

Partial withdrawals

Policyholders can also make partial withdrawals from the cash value. Withdrawals are tax-free up to the amount of premiums paid into the policy, as this is considered a return of the cost basis. Any amount withdrawn exceeding total premiums paid may be subject to income tax. Withdrawals directly reduce the policy’s cash value and can also decrease the death benefit.

Using cash value to pay premiums

Policyholders can also use cash value to pay policy premiums. Once sufficient cash value has accumulated, policyholders may direct the insurer to use a portion of it to cover ongoing premium payments. This can be a useful option during financial strain, allowing the policy to remain in force without out-of-pocket payments.