What Type of Life Insurance Can You Cash Out?

Life insurance policies provide a financial benefit to beneficiaries upon the death of the insured. Some types offer a financial component, known as cash value, which accumulates over time. This cash value grows from premiums paid. Policyholders can access this cash value during their lifetime.

Cash value policies offer more than just a death benefit. This distinguishes them from policies without cash value. Understanding cash value policies and their use is important.

Life Insurance Policies with Cash Value

Certain life insurance policies build cash value, offering a living benefit in addition to a death benefit. Whole life insurance is a permanent policy that accumulates cash value on a guaranteed basis. Premiums remain fixed, with a portion contributing to cash value that grows at a guaranteed rate. This predictable growth shows policyholders how much cash value will be available.

Universal life insurance offers more flexibility, allowing premium and death benefit adjustments. Cash value growth is tied to an interest rate, which can fluctuate. Indexed Universal Life (IUL) links cash value growth to a market index, like the S&P 500, without direct investment. Variable Universal Life (VUL) allows allocation to sub-accounts, similar to mutual funds, with growth depending on investment performance.

Term life insurance does not build cash value. Term policies provide coverage for a specified period (e.g., 10, 20, or 30 years), offering a death benefit if the insured dies within that term. Since term life focuses solely on coverage for a limited duration without an investment component, there is no cash value to access. This is a key distinction between permanent and term life insurance.

How Cash Value Accumulates

Cash value in permanent life insurance policies accumulates through a structured allocation of premium payments. A portion of each premium paid by the policyholder is directed towards the policy’s cash value, separate from the cost of insurance and administrative expenses. This allocation ensures the cash value account steadily increases over time. Initial years often see less allocated due to higher administrative costs and commissions.

Once allocated, the cash value grows through the crediting of interest or investment returns, depending on the policy type. For whole life and traditional universal life policies, the cash value earns interest, often at a guaranteed minimum rate or a rate declared by the insurer. Variable universal life policies, however, link cash value growth directly to the performance of selected investment sub-accounts. The growth in cash value generally occurs on a tax-deferred basis, meaning that earnings are not taxed until they are accessed.

This tax-deferred growth allows the cash value to compound over many years, potentially accumulating a substantial sum. Although the cash value grows, it is distinct from the policy’s death benefit. The primary purpose of the policy remains to provide a death benefit to beneficiaries, and the cash value is a separate component that can influence the death benefit if the policy is surrendered.

Accessing Your Policy’s Cash Value

Policyholders have several methods to access the accumulated cash value within their permanent life insurance policies. One common approach is to take a policy loan, where the policyholder borrows money directly from the insurer, using the cash value as collateral. These loans accrue interest, typically at a variable rate, and are not repaid by the insurer. If the loan, including any accrued interest, is not repaid by the time the insured individual passes away, the outstanding amount will be deducted from the death benefit paid to the beneficiaries.

Another way to access cash value is through withdrawals, also known as partial surrenders. A withdrawal directly reduces the policy’s cash value and typically results in a corresponding reduction in the death benefit. For tax purposes, withdrawals are generally tax-free up to the amount of premiums paid into the policy. Any amount withdrawn that exceeds the total premiums paid is usually taxable as ordinary income.

Policyholders can also choose to fully surrender their policy, which means terminating the coverage entirely. Upon surrender, the policyholder receives the policy’s cash surrender value, which is the accumulated cash value minus any surrender charges and outstanding loans. Surrendering the policy ends all insurance coverage, and the death benefit is no longer in effect. Any gain realized from the surrender, defined as the cash surrender value exceeding the total premiums paid, is generally taxable as ordinary income in the year of surrender.