Life Insurance Cash Out: When And How?

Life insurance can be a valuable financial safety net for loved ones after you die, but it can also provide benefits while you're still alive. Permanent life insurance policies, such as whole life or universal life insurance, build up a cash value over time that can be accessed in several ways. This cash value can supplement your income in retirement, cover college tuition, or fund other large purchases. Here are some options for cashing out your life insurance policy:

- Withdrawing cash: You can withdraw a limited amount of cash, usually up to the total premiums you've paid, without incurring income tax. However, this may reduce your death benefit and could have unintended consequences, such as increased premiums or a reduced policy growth rate.

- Borrowing against the policy: Many policies allow you to borrow money using your cash value as collateral. These loans typically have lower interest rates than personal or home equity loans, and there is no credit check required. However, any unpaid balance will reduce your benefits, and the loan may accrue interest.

- Surrendering the policy: You can cancel your policy and receive the surrender value, which is the cash value minus any fees. This option terminates your coverage, and your beneficiaries will not receive a death benefit. Surrendering a policy may also incur taxes and surrender charges, especially if done early.

- Selling the policy: You can sell your policy to a life settlement company or an individual in exchange for a lump sum payment. The buyer will take over premium payments and receive the death benefit when you pass away. This option usually provides a higher payout than surrendering the policy, but it comes with additional costs and reduces the death benefit for your beneficiaries.

It's important to carefully consider the pros and cons of each option before making a decision, as cashing out your life insurance policy can have long-term financial implications for you and your beneficiaries.

Withdrawing cash from a life insurance policy

Withdrawals

You can make a withdrawal from your policy, which is usually distributed as a lump sum or in payments. The main advantage is that withdrawals are readily available up to a set limit, typically the amount you've contributed. They are generally not taxable if withdrawn from the policy basis (premiums paid). However, withdrawals may reduce your death benefit and may not be an option within the first two years.

Loans

You can take out a loan from your insurance provider, using your policy as collateral. Loans typically have lower interest rates compared to personal or home equity loans, and there is no loan application or credit check. On the downside, loans may incur interest charges, and any unpaid balance will reduce your benefits.

Surrender

You can choose to surrender your policy, which involves cancelling it and receiving the surrender value in cash, usually a lump sum payment. However, surrender fees will reduce the cash you receive, and your beneficiaries will not receive a death benefit when you pass away.

Sell

You have the option to sell your policy to a life settlement company, which will then buy the policy on behalf of financial institutions and investors. Selling your policy will provide a lump sum payment, and you will no longer need to pay premiums. However, your heirs won't receive a death benefit, and you may owe taxes on the sale.

It's important to carefully consider the pros and cons of each option before making a decision, as withdrawing cash from a life insurance policy can have significant financial implications.

Surrendering a life insurance policy

Surrendering a policy is a relatively quick and simple process, but it's important to consider the pros and cons before making a decision.

Pros of Surrendering a Life Insurance Policy

• You'll get some money back, which is better than getting nothing if you let the policy lapse.
• If your policy is no longer needed, surrendering it can free up money that would otherwise be spent on premiums.
• Surrendering a policy can rid you of the burden of a monthly premium.

Cons of Surrendering a Life Insurance Policy

• Surrender fees and taxes can significantly reduce the amount of money you receive.
• Surrendering a policy means you will lose coverage, which could compromise your long-term goals or your family's financial future.
• You will no longer be entitled to the death benefit, which could be a significant amount of money.
• If you later decide you need coverage again, getting the same level of protection may be more complicated or more expensive.

Reasons for Surrendering a Life Insurance Policy

• No longer needing coverage, e.g. children have become financially independent.
• The premiums are too expensive.
• Finding a better policy that offers improved coverage or cheaper premiums.
• Needing cash, either for an emergency or to invest in more lucrative opportunities.

Alternatives to Surrendering a Life Insurance Policy

• Withdrawing cash from your policy: this is usually possible without cancelling the policy, but it will reduce the death benefit and may be subject to tax.
• Taking out a loan from your policy: this won't affect your coverage but will accrue interest and reduce the death benefit if not paid back.
• Selling your policy: this will get you a higher payout than surrendering, but you will still lose coverage.
• Borrowing against your 401(k) plan or taking out a home equity loan.

Borrowing from a life insurance policy

How It Works

When you borrow from a life insurance policy, you are essentially borrowing from yourself. The insurance company lends you money, using the cash in your policy as collateral. This means that the policy's cash value can continue to accumulate, but it's important to understand how interest and any dividends will be determined and paid.

No Credit Check Required

There is no approval process, credit check, or income requirement for a life insurance loan. You are not obligated to qualify for the loan financially, and there is no need to explain how you plan to use the money.

Interest and Repayment

The loan is generally expected to be paid back with interest, though the interest rates are typically much lower than on a bank loan or credit card. There is no mandatory monthly payment, and you can pay off the loan on your own terms. However, if the loan is not paid back, the amount owed, including interest, will be deducted from the death benefit that your beneficiaries receive.

Potential Impact on Death Benefit

Borrowing from your life insurance policy can reduce the death benefit. If you pass away before repaying the loan, your loved ones will receive a lower payout.

Risk of Policy Lapse

If interest accumulates on the loan and is not paid, it will be added to the loan balance. This could cause the loan balance to exceed the policy's cash value, resulting in a policy lapse. If the policy lapses, you may owe taxes on the amount borrowed. Therefore, it is important to make at least the interest payments on time and continue paying your premiums to avoid a lapse in coverage.

Borrowing Limits

The amount you can borrow depends on the cash value of your policy and the rules set by the insurer. Most companies allow you to borrow up to 90% of the policy's cash value. However, it usually takes several years for the policy to build up enough cash value to borrow against.

In conclusion, while borrowing from a life insurance policy can provide quick access to cash, it is important to understand the potential risks and implications. These include a reduced death benefit, the risk of policy lapse, and the accumulation of interest. Be sure to carefully consider your options and consult with a financial advisor or estate planning attorney before making a decision.

Selling a life insurance policy

Selling your life insurance policy is an option if you need cash. This is known as a life settlement, and it involves selling your policy to a third party or life settlement company in exchange for a lump sum. The buyer then takes over premium payments and receives the death benefit when you die.

The amount of money you will receive depends on the value of your policy, your age, health, premiums, and the type of policy you have. According to the Life Insurance Settlement Association (LISA), the average life settlement is 20% of the policy's face value.

There are a few things to consider before selling your life insurance policy:

• You will lose access to the cash value of your policy.
• Your family will not receive the death benefit when you die.
• The money you receive may be subject to taxes and debt collection.
• The extra income may disqualify you from receiving Medicaid and other financial assistance programs.

The process of selling your life insurance policy typically involves the following steps:

• Application: You complete an application and grant the settlement company permission to obtain information about your policy and health.
• Documentation: The settlement company underwriters gather information about your policy and your medical records.
• Appraisal: Underwriters determine the market value of your policy and assess whether it is a good investment.
• Offer: The settlement company makes an offer, which you can accept or decline.
• Closing: If you accept the offer, you review and sign the closing package, and the transaction is finalised.

This process typically takes between 60 and 120 days.

It is important to note that selling a life insurance policy is a serious decision and should not be taken lightly. There may be other options available to access cash, such as withdrawing or borrowing from the cash value of your policy. It is recommended to consult a financial advisor or estate planning attorney before making any decisions.

Using cash value to pay premiums

Using the cash value of a life insurance policy to pay premiums is one of several ways to access the cash value of a permanent life insurance policy. Other ways include withdrawing cash, taking out a loan, or surrendering the policy.

Variable and universal life insurance policies are often favoured as they allow the policy's cash value to be used to pay premiums. This strategy will only work for a short period if the cash value is small or if interest rates are low. It is important to carefully monitor the cash value to make sure it doesn't drop too far, or coverage may be lost. However, if there is a fairly large cash value with consistent returns, coverage can be kept in place for years at little to no additional cost.

For example, if the annual premium is $5,000 and there is $100,000 in cash value, a return of 2.5% interest annually would be needed to cut premium payments in half while maintaining the full cash value.

Whole life insurance policies typically do not let you pay premiums using the policy's cash value, except if you convert to a paid-up policy. Not all insurers offer this option, but with a paid-up life insurance policy, the cash value is large enough that you can stop paying premiums out of pocket. The downside to paid-up whole life insurance policies is that each premium payment is deducted from the policy's death benefit, and less cash value is available for other purposes, such as a policy loan.

Frequently asked questions