Cashing Out A Life Insurance Policy

Eric Van Haaften Permanent Life Insurance

Many people are unaware that life insurance policies can be more than a safety net for beneficiaries after one’s passing; they can also serve as a source of immediate funds during your lifetime.

If you’re facing financial difficulties, the option to borrow against or cash out a life insurance policy is worth considering.

We will cover tax-efficient strategies that policyholders can utilize to unlock the value within their policy for short-term financial relief.

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How do life insurance policies work?
Tips for cashing out a life insurance policy.
What are the tax consequences of cashing out?
How do you use living benefits when you are sick?
How to sell your life insurance policy for cash?
Alternatives to cashing out life insurance.
FAQs: How do you cash out a life insurance policy?

Understanding Life Insurance Policies

Understanding life insurance terminology can be intimidating for many people. But fear not! We’re here to simplify things and break down the different types of policies.

Term insurance plans cover a fixed period, usually 10 to 40 years. Term life insurance doesn’t build any cash value, and you can’t get any money back from it.

However, some term life insurance policies offer a conversion privilege that allows you to convert them into permanent coverage later in life if desired.

On the other hand, permanent coverage provides protection for your entire lifetime and does not have an end date.

One of the benefits of permanent life insurance is that you may be able to access your policy’s cash value in case of an emergency, a major purchase, or a retirement supplement.

If you want to tap into your life insurance policy for income while still alive, consider policies like whole, variable, and indexed universal life insurance.

These permanent policies build cash value over time, which you can borrow against or withdraw based on interest rates or market performance.

Additionally, living benefits riders available on both term and permanent policies allow you to access a portion of the death benefit early in case of a qualifying illness.

Cashing Out a Life Insurance Policy

One of the unspoken benefits of life insurance is that you can cash out before your death.

If you need cash, your life insurance policy might be an unexpected source. But how do you get this money? Let’s look at three standard options.

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How to withdraw money from a life insurance policy

If you decide to withdraw all the cash value accumulated in your policy, you can request the insurance company to issue a check for that amount.

However, it’s important to note that this will typically terminate your coverage and may have tax implications.

Alternatively, you could choose to make partial withdrawals from the cash balance of your policy while still keeping it active. This option allows you to access some funds for short-term needs without altogether ending all benefits.

Check the fine print of your policy before making any withdrawals because insurers often impose early withdrawal penalties, sometimes lasting up to fifteen years.

Plus, if you don’t repay the withdrawal before your death, it will be deducted from the death benefit that your beneficiaries receive.

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how to use a Policy Loan for tax-free cash

A better option is to take out a policy loan. When you borrow against your life insurance policy, the outstanding loan does not interrupt the compounding interest inside your policy.

The policy loan is non-taxable because it is just a personal loan between the insurer and the policy owner, and the cash value is collateral.

Interest rates for life insurance policy loans can be either fixed or variable, depending on the insurer and current interest rate conditions.

While it is recommended to make regular payments to maintain the integrity and benefits of your policy, monthly payments are not mandatory, according to USA Today.

If there’s an outstanding loan balance at the time of your death, it will be subtracted from the death benefit.

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cash in policy by surrendering

Surrendering a life insurance policy is not as straightforward as withdrawing money from a bank account.

When you surrender a life insurance policy, you are essentially canceling it and receiving its surrender value. This value is calculated by subtracting any surrender fees from the cash value of the policy.

However, it’s crucial to understand that by doing this, your coverage will cease to exist. In other words, if you pass away after surrendering the policy, your beneficiaries will not receive a death benefit.

Also, remember that any amount received above the cost basis may be subject to taxes.

Surrendering a policy also means forfeiting any potential investment growth, as well as dividends or interest earned on the policy.

How long does it take to cash out a life insurance policy?

If you have a permanent life insurance policy with accumulated cash value, it could serve as a financial lifeline in an emergency.

However, it typically takes many years of premium payments before the cash value becomes significant enough to be beneficial.

Once you’ve requested a policy loan or withdrawal from your insurer, it can take anywhere from a few days to a few weeks for the funds to be disbursed.

Nevertheless, it’s crucial to consider whether cashing out your life insurance is advantageous in every situation. There may be alternative options that better suit your needs and objectives.

Tax Impact of Cashing in Life Insurance

Understanding the tax consequences of cashing in a life insurance policy before death is an important consideration.

The good news is that comprehending these implications isn’t as complicated as it may seem.

Tax on Withdrawals: Generally, withdrawals up to the total premiums paid into the policy are considered tax-free. This is known as the “cost basis.” But if you withdraw more than this cost basis, the additional amount becomes taxable income.
Taxes on Loans: Borrowing money from your life insurance policy is typically tax-free. However, if the loan causes your policy to lapse, the outstanding balance becomes subject to taxation.
Taxes Upon Surrendering: If you choose to surrender your policy for its cash value, be aware that any amount exceeding the total premiums paid will likely be considered ordinary income. Plus, any outstanding loans against the policy may be treated as taxable income.

It’s always wise to consult with a financial advisor or tax professional who can provide guidance specific to your situation and help ensure compliance with applicable tax laws.

Cashing Out with Living Benefits

Many term insurance plans and permanent life insurance policies provide living benefits riders, allowing policyholders to access their policy funds before death.

These riders are known as accelerated death benefits and are typically only available for terminal or chronic illnesses, as well as long-term care needs.

To qualify for living benefits, policyholders must provide evidence of a reduced life expectancy of 24 months or less.

Terminal Illness: This applies when a policyholder is diagnosed with a terminal illness with an expected lifespan of two years or less. The payout is typically given as a lump sum payment.
Chronic Illness: This lump sum benefit can be accessed by policyholders who cannot perform at least two daily activities independently or have a life expectancy of 24 months or less.
Critical Illness Benefit: This benefit applies to individuals who have experienced specific qualifying conditions such as cancer, heart attack, or stroke.
Long-Term Care: Policyholders who require assistance with everyday tasks like bathing or using the restroom qualify for this benefit. However, there may be an elimination period before receiving payments, generally made monthly.

It’s important to review your policy and understand what living benefits are included to determine your eligibility and use these options effectively.

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Cashing In With Life and Viatical Settlements

If you no longer require coverage or need immediate cash, it’s worth considering life or viatical settlements.

Life and viatical settlements offer a means to convert your life insurance policy into cash by selling it to an outside investor.

In exchange for a lump sum payment, the investor assumes responsibility for paying premiums and receiving the death benefit.

The distinction between these settlements lies in the policyholder’s health condition and projected lifespan.

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Cashing out with Life settlements

Settlements are available to policyholders who are typically aged 65 or older and have a life expectancy of more than two years.

These individuals may choose to sell their life insurance policies for various reasons, such as no longer needing the coverage, inability to afford the premiums, or a desire to utilize the funds elsewhere.

The taxation of life settlements depends on factors like the amount received and the policy’s cost basis, with income or capital gains tax applicable.

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Cashing out with viatical settlements

On the other hand, viatical settlements cater specifically to policyholders facing terminal or chronic illnesses that shorten their life expectancy to less than two years.

By selling their policies through accredited viatical providers adhering to NAIC standards, these individuals can access funds for medical expenses, daily living costs, or other requirements.

Notably, under IRS guidelines and provided specific criteria are met regarding illness severity and sale conditions, viatical settlements generally enjoy tax-free status to alleviate financial burdens during challenging times.

Alternatives to Cashing Out Life Insurance

If you’re looking for alternatives to cashing out your life insurance, several options are worth considering. These alternatives can give you the money you need without risking your life insurance coverage.

If you own a home, accessing its equity through a home equity loan,cash-out refinancing, or a reverse mortgage might be viable choices.

Home Equity Loan: You can borrow against the value of your property and receive cash in return.
Cash-out Refinancing: This involves taking out a new mortgage larger than what is currently owed on your home and receiving the difference as cash.
Reverse Mortgage: If you are 62 or older and have paid off most or all of your mortgage, consider exploring reverse mortgages, which allow homeowners to tap into their home’s equity tax-free by receiving regular payments or one lump sum.

If you do not own your home, the obvious choice is to apply for a personal loan or credit card. Depending on your credit score, you may be able to secure a personal loan or credit card with a competitive interest rate.

Armed with this knowledge, you can now confidently make decisions about whether you should utilize the cash from your life insurance or seek out alternatives for your liquidity needs.

FAQs: How to Cash Out a Life Insurance Policy

Can you cash out life insurance while living? Permanent insurance policies allow policyholders to withdraw or borrow funds from their cash value accounts while still alive.

What is the penalty for cashing out a life insurance policy? If you decide to cash out your life insurance policy, a surrender fee may be involved. It’s crucial to carefully review your policy contract, as surrender fees can reach up to 40% in the policy’s early years.

How soon can I borrow from my life insurance policy? You cannot borrow against your life insurance policy right away. It takes several years for your policy’s cash value to reach a certain threshold before you can take out a loan.

How do I avoid tax on life insurance cash value? To avoid paying taxes on withdrawals from your policy’s cash value, you should withdraw no more than what you’ve paid in premiums. This strategy ensures you’re not taxed on any earnings or growth accrued within the policy.

Who gets the cash surrender value of life insurance? The cash surrender value is the money you receive if you cancel the policy before it reaches maturity. This cash value represents the savings portion found in most whole-life and universal-life policies.