Life insurance can provide financial security for your loved ones after you pass away. But did you know that it can also provide cash for you while you’re still alive? If you have a cash value life insurance policy, such as whole life or universal life insurance, you have the option to cash out or access the cash value. In this article, we will explore the different ways to cash out a life insurance policy and the pros and cons of each method.
Can You Cash Out a Life Insurance Policy?
If you have a cash value life insurance policy, you can cash out or surrender the policy to access the cash value. When you cash out your policy, you will receive the cash value minus any surrender fees. It’s important to note that surrendering the policy will terminate the coverage.
If you don’t want to cancel your policy entirely, you have other options. You can withdraw money from the cash value or take out a loan against the policy. Let’s explore these options in detail.
How Do I Cash Out My Life Insurance Policy?
Before cashing out your life insurance policy, consider your overall financial plan and whether you have enough assets to leave behind for your dependents if you pass away. Once you’ve made your decision, here are the ways to access the cash value:
1. Make a withdrawal
You can simply take money out of the cash value by making a withdrawal. The amount you can withdraw is limited to the premiums you’ve paid, and it is tax-free. However, withdrawals will reduce the death benefit.
2. Take out a loan
Another option is to take out a loan against your life insurance policy. Policy loans are tax-free and allow you to borrow money from the cash value. You can either pay back the loan with interest or have the amount deducted from the death benefit. Keep in mind that the loan amount and interest will be deducted from the death benefit if you don’t repay it.
3. Surrender the policy
By surrendering the policy, you can cancel the coverage and receive the full cash value minus any surrender fee. However, you will have to pay taxes on any gains earned on the cash value, and your beneficiaries will not receive a death benefit.
4. Sell the policy
If you need a larger sum of cash, you can consider selling your life insurance policy to a third party. This is known as a life settlement. The third party will pay you a lump sum of money that is greater than the cash value but less than the death benefit. The buyer will then take over the premium payments and collect the death benefit when you pass away.
Withdrawing the Cash You Need
Once you’ve decided how you want to access the cash value, it’s a straightforward process. Simply contact your insurance company and inform them of the amount you wish to withdraw. They will wire the cash to you or deposit it into your bank account.
It’s important to note that withdrawals are taken first from the premiums you’ve paid, which are considered a return of your basis and are tax-free. If you tap into the earnings portion, you will have to pay taxes on the gains at your regular income tax rate.
While withdrawing cash from a life insurance policy is a viable option, keep in mind that it will reduce the death benefit your beneficiaries receive.
Cash Withdrawal Pros and Cons
Pros:
- No interest is paid on a withdrawal.
Cons:
- A withdrawal reduces your policy cash value and death benefit.
- The withdrawal may be taxable if it exceeds the amount of premiums paid.
Borrowing the Cash You Need
Instead of withdrawing cash from your policy, you can choose to borrow the money. Borrowing from your life insurance policy can be a convenient way to get cash for various purposes, such as a car purchase or retirement income.
Policy loans are tax-free and don’t require a loan application or credit check. You can repay the loan on your own schedule, and the money goes back into your policy instead of to a lender. However, it’s important to note that the interest rate on policy loans may be higher than other options. If you don’t pay back the loan, it will be subtracted from the death benefit.
The benefit of a policy loan is that you can continue earning interest on the outstanding loan amount, which can help offset the interest charges. However, be cautious not to borrow too much, as it can lead to the policy lapsing if the loan amount and interest owed exceed the total cash value.
Policy Loan Pros and Cons
Pros:
- No loan application or credit check.
- You can repay the loan on your own schedule, and the money goes back into your policy.
- You may earn a positive arbitrage on the money you borrow.
Cons:
- The interest rate may be higher than other options.
- The loan will be deducted from the death benefit if you don’t repay it.
Surrendering the Policy for Cash
If you need the full cash value of your policy, you have the option to surrender the policy entirely. By surrendering the policy, you will receive the full cash value minus any surrender charges. However, you will be required to pay taxes on any gains earned on the cash value, and surrendering the policy will terminate the coverage.
Surrendering a policy should be considered as a last resort. If you’re having trouble paying the premiums, there are other options available to help you keep some coverage in place, such as reducing the face value or using the cash value to convert the policy to paid-up status.
Policy Surrender Pros and Cons
Pros:
- If the surrender value is greater than the surrender charge, you will receive money in your pocket.
Cons:
- Possible surrender charges may eliminate any cash value.
- You may have to pay taxes on the gains.
- Your heirs will not receive a death benefit.
Sell Your Policy for Cash
If you need a significant amount of cash and the need for life insurance is not a priority, you can explore the option of selling your life insurance policy through a life settlement. A life settlement involves selling your policy to a third party for a lump sum that is greater than the cash value but less than the death benefit.
To qualify for a life settlement, you typically need to be a certain age or have specific health impairments. The older you are or the more severe your health condition, the better chances you have of getting a higher payment. It’s important to work with reputable life settlement companies and obtain offers from multiple sources.
Keep in mind that there can be fees associated with life settlements, and you will need to pay income taxes on the amount you receive from the sale of the policy.
Life Settlement Pros and Cons
Pros:
- You’ll receive more cash than surrendering your policy.
Cons:
- There are restrictions to qualify for a life settlement.
- The cash offer will be less than the death benefit.
Alternatives to Cashing Out Life Insurance
If you bought a life insurance policy as a safety net for your loved ones, there may be alternative ways to obtain cash without cashing out the policy. Consider the following options:
- Take out a home equity loan, utilizing the equity in your home.
- Obtain a personal loan for smaller cash needs.
- Consider a credit card with a 0% introductory rate for quick repayment.
- Explore borrowing from a retirement account, such as a 401(k) loan, which offers lower interest rates compared to personal loans.
FAQs
Q: Can I cash out my life insurance policy?
A: If you have a cash value life insurance policy, you have the option to cash out or access the cash value.
Q: Will I have to pay taxes if I cash out my life insurance policy?
A: When you cash out your life insurance policy, you may have to pay taxes on any gains earned on the cash value portion.
Q: What happens to my life insurance coverage if I surrender the policy?
A: Surrendering a policy will terminate the coverage, and your beneficiaries will not receive a death benefit.
Q: What is a life settlement?
A: A life settlement involves selling your life insurance policy to a third party for a lump sum that is greater than the cash value but less than the death benefit.
Q: Are there alternatives to cashing out a life insurance policy?
A: Yes, you can explore options such as home equity loans, personal loans, credit cards with introductory rates, or borrowing from a retirement account.
Conclusion
Cashing out a life insurance policy can provide immediate cash, but it’s important to weigh the pros and cons of each method and consider your long-term financial goals. Whether you choose to withdraw money, take out a loan, surrender the policy, or sell it through a life settlement, make sure to consult with a financial advisor or insurance professional to fully understand the implications.
