Whole Life Insurance: Cashing Out A Lapsed Policy?

Whole life insurance is a type of permanent life insurance that offers a death benefit and a cash value account. While whole life insurance is intended to provide financial protection for loved ones after the policyholder's death, the cash value component can also be accessed by the policyholder while they are still alive. This can be done through a withdrawal, loan, or surrender of the policy. However, it's important to carefully consider the advantages and disadvantages before cashing out whole life insurance, as it may result in tax consequences and a lower death benefit for beneficiaries. Additionally, failure to pay premiums and a lapse in coverage can lead to the loss of benefits.

Surrendering your life insurance policy

You might choose to surrender your life insurance policy if you no longer need or want it. For example, you might have found a better deal, or you can no longer afford the premiums. You might also need a large amount of cash quickly.

Before you surrender your policy, check your documents for information about cash surrender value, surrender charges, and other relevant terms. Then, speak with your insurer, who will guide you through the process. You'll need to fill out some paperwork, and your insurer will calculate your final payout. This will be your cash value balance minus any surrender fees or outstanding loans on your policy.

You may have to pay taxes on your life insurance surrender value as taxable income. You'll only pay income tax on interest or earnings over the amount you paid into the policy. Consult a tax expert to make sure you report everything properly.

Alternatives to surrendering your policy

If you don't want to surrender your policy, there are other ways to access your cash value. These include:

• Borrowing from your cash value: You can borrow against your permanent life plan's cash value, often at low interest rates and on favourable terms. There's no due date for repaying the loan, but interest will accumulate on your outstanding balance. Be careful, though—if the loan balance grows larger than your remaining cash value, your policy could lapse.
• Withdrawing from your cash value: Withdrawing your cash value lets you access your wealth without a loan and without surrendering your policy. However, withdrawals may trigger tax consequences if you withdraw more than your total premiums paid, and they will reduce your death benefit.
• Using your cash value to pay premiums: Many permanent life insurance policies let you pay premiums with your cash value. This can help you cut your life insurance costs while maintaining full coverage, but if you drain your cash value, your policy could lapse.

Making a withdrawal from your policy

If you have a permanent life insurance policy, you may be able to access the cash value of your policy. Whole life, universal life, and variable universal life are types of permanent life insurance policies that never expire and maintain a cash value in addition to a death benefit.

Make a withdrawal

You can take money out of the cash value of your policy. Withdrawals are typically tax-free up to the amount you've paid in premiums. Withdrawing more than this may result in tax consequences. Withdrawals will reduce the death benefit.

Take out a loan

You can borrow money from the cash value of your policy. There is typically no credit check, and repayment terms are flexible. However, any amount you owe on the loan's principal and interest is typically deducted from the death benefit when you die. Interest accumulates on your outstanding balance, and if the balance exceeds the cash value, your policy could lapse.

Surrender your policy

You can withdraw the entire cash value of your policy by surrendering your coverage. You'll receive all the money you've paid towards your coverage and any interest you've earned, minus any surrender fees and federal taxes. This will cancel your coverage.

Sell your policy

You can sell your policy to a third party for a lump sum that is greater than the cash value but less than the death benefit. This is known as a life settlement. The buyer will then pay the premiums, and when you die, they will receive the death benefit.

Cover your policy's monthly payments

If you need cash to meet other expenses, you may be able to draw on your cash value account to cover the policy premium. This can help you get through a tough financial spot without forfeiting your policy. However, if you deplete your cash value, your insurance could lapse, ending your coverage.

Borrowing from your policy

Borrowing from your whole life insurance policy can be a quick and easy way to get cash in hand when you need it. However, there are a few things to keep in mind before taking out a loan from your policy.

First, it's important to understand that you can only borrow against a whole life insurance policy or a universal life insurance policy. These types of policies are more expensive than term life insurance but have no predetermined expiration date. If you stop paying premiums, the policy is in force for the rest of your life. While the monthly premiums are higher than term life insurance, the money paid into the policy that exceeds the cost of insurance builds up a cash value that is part of the policy. This cash value can be borrowed against, but it usually takes a few years for this value to build up sufficiently.

When you borrow from your whole life insurance policy, you are essentially borrowing from yourself. The insurance company lends you the money and uses the cash value of your policy as collateral. There is no credit check or approval process, and you can use the money for anything you want. The interest rate on a life insurance loan is typically between 5% and 8%, which is lower than credit card interest rates and slightly lower than personal loan rates. You are not required to make fixed monthly payments, and there is no set time limit for repayment. However, the longer you take to repay the loan, the more interest you will pay.

It's important to remember that a policy loan will reduce the death benefit your beneficiaries will receive if you don't pay it back. Additionally, if you don't make interest payments, your policy could lapse, and the entire loan amount could become taxable. Therefore, it's crucial to have a repayment plan in place and regularly review your policy to ensure the loan balance is not growing faster than expected.

Overall, borrowing from your whole life insurance policy can be a convenient way to access cash, but it's important to understand the risks and potential impact on your death benefit and tax liability.

Pros and cons of cashing out your life insurance

Cashing out your life insurance can be a quick way to get your hands on some much-needed cash. However, it's important to understand the potential pros and cons before making any decisions. Here are some things to consider:

Pros:

• No interest on withdrawals: Withdrawing money from your life insurance policy is a simple process and does not incur any interest charges.
• No loan application or credit check: Policy loans are generally easy to obtain as they are based on the cash value of your policy, not your creditworthiness.
• Flexible repayment: You can repay a policy loan on your own schedule, and your payments go back into your policy.
• Low-interest rates: Interest rates on life insurance loans are typically lower than credit card interest rates and slightly better than personal loan rates.
• No impact on credit score: Taking out a policy loan will not affect your credit score, unlike other types of loans or credit card applications.

Cons:

• Reduced death benefit: Withdrawing or borrowing money from your policy will reduce the death benefit that your beneficiaries will receive.
• Tax implications: Withdrawals or loans that exceed the amount of premiums paid may be subject to taxes. Surrendering your policy may also result in taxes on any gains earned.
• Policy lapse: If you borrow a substantial amount and accrue interest that exceeds your cash balance, your policy could lapse and be closed by your insurer. This could result in a large tax bill.
• Surrender charges: Surrendering your policy may incur surrender charges, especially if done during the early years of the policy.
• Loss of coverage: Surrendering your policy means giving up your life insurance coverage, and you will need to purchase a new policy if you want coverage in the future.
• Limited access: You may not be able to access your cash value right away, as it takes time to build up.

Before deciding to cash out your life insurance, it's important to weigh the pros and cons carefully and consider alternative options such as personal loans, home equity loans, or borrowing from a retirement account. Additionally, consult with a tax professional to understand the potential tax implications of your decision.

Alternatives to cashing out life insurance

If you're looking for alternatives to cashing out your life insurance policy, there are a few options to consider. Here are some suggestions:

• Take out a home equity loan or line of credit: If you own a home, you can borrow against the equity you've built up. This option can provide access to a large amount of funds with favourable repayment terms. However, it's important to remember that your home is used as collateral for this type of loan.
• Personal loans: Personal loans can provide a quick way to borrow a sum of money, typically ranging from $1,000 to $50,000. This option may be suitable if you need a smaller amount of cash and want to avoid drawing from your life insurance policy.
• Credit cards with a 0% introductory rate: For smaller cash needs, a credit card with a 0% APR or low-interest rate may be a viable option. This can help you cover short-term expenses without incurring high-interest charges.
• Borrow from a retirement account: Depending on your age and retirement plan, you may be able to borrow from your retirement savings. For example, with a 401(k) account, you can typically start making withdrawals at age 59½.
• Adjust your term life insurance coverage: If your premiums are becoming unaffordable, consider adjusting your coverage level. Many insurance companies are willing to work with you to find a more suitable plan.
• Convert to a permanent life insurance policy: If you have a term life insurance policy, you may be able to convert it into a permanent policy that builds cash value, such as whole life, universal life, or variable universal life insurance. Keep in mind that this option will likely result in higher premium payments.
• Cancel your term life insurance policy: If you no longer need the coverage or want to eliminate premium payments, you can cancel your term life insurance policy. However, keep in mind that you will not receive any benefits if you choose to cancel.

Frequently asked questions