Life Insurance Payouts: Can You Cash Them In?

Life insurance is a way to provide financial protection for your loved ones after your death. But did you know that certain types of life insurance policies can also offer a cash payout while you're still alive? This is known as cashing in your life insurance, and it's an option that comes with several pros and cons. In this article, we'll explore the topic of cashing in life insurance in the UK, including the different types of policies that offer this benefit, how to access the cash, and the potential advantages and disadvantages of doing so.

Withdrawing money from a permanent life insurance policy

Withdrawing Money

Borrowing Money

Borrowing money from a permanent life insurance policy is another option. This allows you to take a loan from the insurer, with your policy serving as collateral. There is usually no loan application or credit check required, and interest rates tend to be lower than those for personal loans or home equity loans. It is not mandatory to repay the loan, but any outstanding balance will typically be deducted from the death benefit.

Surrendering the Policy

Surrendering your permanent life insurance policy means cancelling it and receiving a cash payment, known as the surrender value. This option should be carefully considered as it results in the loss of life insurance coverage. Additionally, surrender fees can be significant, especially for newer policies, and you may have to pay taxes on any gains made through the investment portion of the policy.

Using Cash Value to Pay Premiums

Another option is to use the cash value of your permanent life insurance policy to pay your premiums, thus freeing up money in your budget for other expenses. This is a popular choice for older policyholders who wish to use their retirement income for living expenses while maintaining life insurance coverage.

Selling the Policy (Life Settlement)

Selling your life insurance policy to an individual or a life settlement company is another way to access cash. This option typically provides a larger sum of money than surrendering the policy, as the buyer will continue paying premiums and receive the death benefit when you pass away. However, there are downsides to consider, such as losing control of the death benefit and potential fees and commissions that can reduce the net amount received.

It is important to carefully consider the advantages and disadvantages of each option before making a decision. Additionally, it is recommended to consult with a financial professional to ensure you make the choice that best aligns with your financial goals and circumstances.

Borrowing against a permanent life insurance policy

Types of Policies

Only permanent life insurance policies, such as whole life or universal life insurance, build up a cash value that you can borrow against. Term life insurance, on the other hand, is designed to last for a limited period and does not have a cash value component.

Loan Amount and Interest

The amount you can borrow is based on the value of the policy's cash accumulation account and the contract's terms. Typically, you can borrow up to 90% of the policy's cash value. Interest rates for life insurance loans are generally lower than those for personal loans or credit cards, ranging from 5% to 8%. However, interest will accrue on the loan balance, and if left unpaid, it can cause the policy to lapse.

Impact on Death Benefit

Borrowing against your life insurance policy will reduce the death benefit if the loan is not paid off. The outstanding loan balance, including interest, will be deducted from the death benefit that your beneficiaries receive.

Tax Implications

Borrowing from a life insurance policy is generally tax-free. However, if the loan is not repaid or the policy lapses, you may owe taxes on the amount borrowed. Additionally, if you surrender the policy, the gain on the policy is subject to income tax.

Advantages

Borrowing against a life insurance policy offers several advantages. There are no credit checks or approvals required, and you can use the money for any purpose without justification. You also have the flexibility to repay the loan on your own schedule, as there is no mandatory monthly payment.

Disadvantages

Despite the benefits, there are some serious disadvantages to consider. Borrowing against your policy may slow down the growth of your cash value. Additionally, if the loan remains unpaid and the cash value dips too low, your policy could lapse, resulting in a loss of coverage and potential tax penalties.

Surrendering a permanent life insurance policy

Put simply, you are cancelling your life insurance policy with your provider. You can do this at any time and you’ll receive all of the value of the policy, although there may be some administration charges applied that could reduce the amount you receive.

The cash value is the amount of money that is in your account at any given time. Your provider uses a portion of your money to make investments on your behalf and then, depending on how well these investments perform, credits your policy accordingly.

Surrender value and cash value can be easily confused. The surrender value is the actual amount of money you will get if you decide to access the money in your policy. There is often an administration fee or penalty that is applied, which can affect how much you will be paid.

Almost all policies have a surrender charge, which can be as high as 35% or more, depending on the elapsed period of time since the policy was taken out. So, although your cash value might be £10,000, the provider could charge you a 35% early withdrawal fee of £3,500, leaving you with a surrender value of £6,500.

Pros

If the policy has a surrender or cash value above the surrender charge, that is money in your pocket.

Cons

• Possible surrender charges might wipe out any cash value.
• You might have to pay taxes.
• Your heirs will not receive a death benefit.

Using the cash value to pay your premium

If you build up enough money in your cash value account, you can use it to cover your premium payments. This can be especially helpful if you're retired and need to reduce your monthly expenses but want to keep your policy in place.

Once your cash value reaches a certain point, some insurers and policies will allow you to use it to pay for your coverage. It's important to check with your insurer to determine which cash value options are available to you and understand the requirements and costs.

If you're struggling to make premium payments, using your cash value to cover them could provide some relief and help you keep your life insurance policy in force. Speak with your insurance agent to find out what rules apply.

It's worth noting that any amount taken from your cash value account and not repaid before your death will reduce the death benefit paid to your beneficiary. Therefore, it's crucial to carefully consider the impact on your death benefit and account growth before deciding to use your cash value to pay your premiums.

Understanding Cash Value Life Insurance

Cash value life insurance is a type of permanent life insurance that features a cash value savings component. The policyholder can use the cash value for various purposes, such as borrowing or withdrawing cash or using it to pay policy premiums.

Permanent life insurance policies, such as whole life and universal life, can accumulate cash value over time. A portion of each premium payment is allocated to the cost of insurance, while the remainder is deposited into a cash value account.

The cash value of life insurance earns interest, and taxes on the accumulated earnings are deferred. As premiums are paid and interest accrues, the cash value builds over time. This cash can be accessed for a variety of purposes during the insured's lifetime.

It's important to note that cash value life insurance is typically more expensive than term life insurance due to the cash value element. Additionally, the cash value may be subject to taxes if it exceeds certain limits set by the tax code.

Selling your term life insurance policy

• Determine if your policy is convertible: When signing up for term life insurance, you may have been asked if you wanted to add a conversion rider. This rider allows you to convert a term life policy into a whole life policy. Typically, you must exercise your conversion privilege before the policy expires and before you turn 65 or 70.
• Read your conversion rider carefully: Most conversion riders have expiration dates. If your term life policy is nearing its end, review the rider to ensure it's still valid.
• Consider your health and age: Your health and age will affect settlement offers. Generally, younger and healthier people receive a smaller payout from a life settlement, if they qualify at all.
• Check if you qualify for a life settlement: Before making changes to your life insurance policy, check if you would qualify for a life settlement if you converted the policy.
• Explore additional options: Before finalising the sale of your policy, understand all your options. If you're healthier and can afford your premiums, you may wish to hold onto the policy for the duration of the term.
• Have your policy appraised by a life settlement company: To sell your term life policy, you need to reach out to a life settlement company to receive an appraisal.

The process of selling your term life insurance policy:

• Find an experienced life settlement provider: Research the life settlement industry to find a potential buyer. Licensed life settlement providers will have a deep understanding of the specifics of life settlements.
• Meet the qualifying factors: Check that you meet the minimum qualifying factors, such as owning a policy with a death benefit of £100,000 or more.
• Take a detailed health questionnaire: If the basic qualifying factors are met, you'll complete a detailed health questionnaire.
• Provide authorisation to the provider: The insured and the policy owner will need to authorise the life settlement provider to access medical records and contact the insurance company.
• Share your policy details: You'll need to provide a copy of the policy contract and a premium illustration.
• Wait for the underwriting process to be completed: The life settlement company will evaluate your policy and medical records to determine its value.
• Review the offer: If your policy qualifies, the life settlement company will make an offer. You can accept the full cash offer or opt for an alternative such as a Retained Death Benefit.
• Complete the closing process: This is the transfer of ownership of the policy and all accompanying documentation. Your settlement payment will be placed in escrow until the insurance company has verified the change of ownership.

Frequently asked questions