Life Insurance Payout Before Death: Is It Possible?

Life insurance is a contract between a policyholder and an insurance company that pays out a death benefit when the insured person passes away. While the primary benefit of life insurance is that you can leave money to your beneficiaries when you die, there are circumstances that allow you to claim cash from a policy while you’re still alive. This is known as cashing out your life insurance policy.

Cashing out a life insurance policy before death

On the other hand, permanent life insurance policies, such as whole life and universal life, are designed to cover you for the rest of your life and have a cash value component that can be cashed out while you are still alive.

Withdrawing your entire cash value

If you have a whole life insurance policy and need money, you can cash it out entirely to get the full cash value that has built up. However, this option requires you to surrender your policy, which means your coverage will end, and you will no longer have life insurance. Additionally, you will likely have to pay surrender charges and income taxes on the money you withdraw.

Making a partial withdrawal

Another option is to take a partial withdrawal from your life insurance policy's cash value. With this option, you don't have to surrender your policy, so your loved ones will still receive a death benefit when you pass away, although it will likely be smaller than originally intended. Check if the money you withdraw will be subject to taxes.

Borrowing money from your life insurance

If you have had your life insurance policy for several years, you may be able to borrow from its cash value. In most cases, you won't have to pay taxes on the money you borrow, but the insurance company will deduct interest payments from your cash value balance. The interest rate is usually lower than that of credit cards or bank loans, and the loan does not affect your credit score. If you repay the loan and interest in full before your death, your loved ones will receive the full death benefit. However, if you pass away before fully repaying the loan, the balance you owe, plus interest, will be subtracted from the death benefit.

Surrendering your life insurance policy

You can also choose to surrender your life insurance policy, which means giving it up and forfeiting any death benefits. By doing this, you will receive the total amount of the cash value minus any fees or penalties. However, you will lose your insurance coverage, and you may have to pay surrender fees and taxes on the money you receive.

Selling your life insurance policy

If you have a term life insurance policy, you may have the option to sell it to a third-party company through a life insurance settlement. However, you will sell it for less than the death benefit, and your beneficiaries will no longer be covered in the event of your death.

It is important to carefully consider your options and understand the fees, taxes, and implications associated with cashing in your life insurance policy before making any decisions.

The death benefit of a life insurance policy

The death benefit is typically tax-free and can be paid out all at once or over time. However, if the benefit is received in the form of annuity payments, the beneficiary may have to pay taxes on any interest accrued. The death benefit can also be converted into an annuity, which then makes regular payments over a certain period or for the lifetime of the beneficiary.

There are different types of death benefits, including:

• Accidental death benefit: This only pays out if the insured dies due to a qualifying accident listed in the policy.
• All-cause death benefit: This pays out regardless of how the insured dies, unless specifically excluded from the policy.
• Accidental death and dismemberment: This pays out if the insured dies due to an accident and for other qualifying major injuries such as the loss of a limb, paralysis, or blindness.

The death benefit amount, also known as the face amount, is chosen by the policyholder when purchasing the policy. In many cases, this benefit is fixed and remains the same throughout the life of the policy. However, under certain circumstances, the death benefit may increase or decrease over time, depending on how the policy is structured and used.

The death benefit can increase in the following ways:

• Increasing death benefit option: Some universal life policies offer an increasing death benefit, where the benefit grows alongside the cash value.
• Participating whole life policies: The policyholder can earn dividends, which can be used to purchase paid-up additions, effectively increasing the death benefit without additional premium payments.
• Accidental death benefit rider: If the policyholder adds this rider to their policy, the death benefit can increase if the insured passes away due to an accident.

The death benefit can decrease in the following ways:

• Withdrawals and policy loans: If policyholders borrow against the cash value of their permanent life insurance policy and do not repay the loans, the outstanding amount is deducted from the death benefit.
• Withdrawal: A permanent reduction of the policy's cash value and death benefit.
• Loan: A policy loan that uses the cash value as collateral. Any unpaid loans at the time of death will be deducted from the death benefit, along with accrued interest.
• Flexible premiums: In universal life policies, policyholders may choose to pay lower premiums over time, which could reduce the policy's cash value and impact the death benefit.
• Living benefits: If the policyholder takes advantage of living benefits, such as accessing funds for a terminal illness, this will reduce the overall death benefit.

In most cases, the beneficiaries of a death benefit are the policyholder's partner, children, or other close loved ones. However, any person or organisation can be named as a beneficiary. When naming multiple beneficiaries, the policyholder specifies how much of the death benefit each beneficiary will receive. Contingent beneficiaries can also be named, who will only receive the benefit if all primary beneficiaries are no longer alive.

How to file a claim on a life insurance policy

While the process for filing a life insurance claim can vary depending on the insurer, here is a general step-by-step guide on how to file a claim on a life insurance policy:

Step 1: Find the Policy or Contact the Insurer

Firstly, find the insured's life insurance policy, which will have the insurance company's contact information and claim instructions. If you are unable to find the policy but know the name of the insurance company, they should be able to track down the policy information once you provide certain details about yourself and the deceased. The insurer may then send you a claim form to complete or direct you to an online claim form.

Step 2: Gather the Required Documentation

The claim form and instructions should indicate all the information you need to submit with your claim, including personal details about the deceased and yourself, and the death certificate. It is a good idea to obtain multiple certified copies of the death certificate, as you may need these for other purposes, such as closing accounts and utilities.

Step 3: Complete the Claim Form

Complete the claim form and gather all the required documentation. You will likely need to provide the following:

• The insured's name, date of birth, date and cause of death, and state of residence
• The insured's Social Security number and/or the policy number
• The insured's original or a copy of the certified death certificate

Step 4: Choose Your Payout Type

You may have the option of receiving your payout as a lump sum, which is the most common choice, or as a life insurance annuity, which would pay out regularly over a specified timeframe. Consult the insurer about your options and seek advice from a financial advisor regarding the financial implications of the differing payout types.

Step 5: Submit Your Claim

Once you have completed the claim form, gathered all the required documentation, and decided on your payout preference, you can submit your claim to the insurer. If there are no issues, you may receive your payout within a few days to a couple of weeks.

The taxability of cashing out a life insurance policy

Whether or not you will have to pay taxes on a cashed-out life insurance policy depends on the type of policy and the amount you withdraw.

If your life insurance policy has a cash value component, you can withdraw limited amounts of cash from it. The amount available differs based on the type of policy and the company issuing it. Cash-value withdrawals are not taxable up to your policy basis, as long as your policy is not classified as a modified endowment contract (MEC). MECs are life insurance policies in which the cash contained exceeds federal tax-law limits.

If you withdraw up to the amount of the total premiums paid into the policy, the transaction is not taxable as it is considered a return of premiums. However, if you then withdraw any gains on the policy (like dividends), these amounts may be taxed as ordinary income.

If you take a withdrawal during the first 15 years of the policy and the withdrawal causes a reduction in the policy's death benefit, some or all of the withdrawn cash could be subject to taxation. Withdrawals are treated as taxable to the extent that they exceed your basis in the policy.

If you borrow money from your life insurance policy, the amounts are generally not taxable. However, if the loan is still outstanding when the policy lapses or is surrendered, the borrowed amount becomes taxable to the extent that the cash value (without reduction for the outstanding loan balance) exceeds your basis in the contract.

If you surrender your policy, you will likely have to pay income tax on any gain in the policy. If there is an outstanding loan balance against the policy, additional taxes could be incurred.

If you sell your life insurance policy to a third party through a life settlement, you will generally only pay taxes on the amount above what you paid in premiums.

In summary, while there are certain situations in which you can cash out your life insurance policy before you die, it is important to carefully consider the tax implications and potential penalties involved before doing so.

Choosing a life insurance beneficiary

Who Can Be a Life Insurance Beneficiary?

Almost anyone can be a life insurance beneficiary, including people, organizations, and trusts. Some common examples include a spouse, children, a charitable organization, or a legal entity like a company. However, if you live in a community property state and used money earned during your marriage to pay your life insurance premiums, your spouse may automatically be entitled to a percentage of the death benefit. In this case, your spouse must give written consent for you to designate someone else as a beneficiary. The nine community property states are Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin.

Primary vs. Contingent Beneficiaries

Primary beneficiaries are the first in line to receive the life insurance death benefit if you die. Contingent beneficiaries, also known as secondary beneficiaries, will receive the death benefit if the primary beneficiary dies before you do. You can have multiple primary and contingent beneficiaries and choose how much of the payout each party receives. It's important to be specific when designating a beneficiary to avoid disputes between your loved ones.

Irrevocable vs. Revocable Beneficiaries

An irrevocable life insurance beneficiary designation cannot be changed without the beneficiary's approval. This means that you cannot remove or edit the payout for irrevocable beneficiaries without their consent. On the other hand, a revocable life insurance beneficiary designation is flexible and can be changed, updated, or removed at any time.

Naming Children as Beneficiaries

If you name minor children as beneficiaries, the payout can be complicated. In most states, legal guardians can receive payouts on their behalf, but this can be a lengthy and expensive process. Alternatively, you can set up a trust for your children and have a trustee oversee the funds and distribute the money according to your wishes.

Notifying Beneficiaries

While it is not required, it is recommended to notify your beneficiaries and provide them with a copy of your life insurance policy. This will ensure that they are aware of the policy and able to file a claim when the time comes.

Frequently asked questions