Maximizing Life Insurance: Can You Withdraw Your Cash Benefits?

Life insurance policies can be cashed out before death, but this depends on the type of policy you have. Whole life, universal life, and permanent life insurance policies build up a cash value over time, which can be withdrawn, but term life insurance policies do not build up cash value and therefore cannot be cashed out. If you cash out your life insurance policy, you will not receive the full stated value of the policy, but rather the cash value, which is likely to be significantly lower. Cashing out your life insurance policy will also mean that your beneficiaries will no longer receive a payout when you die.

Withdrawing cash from a life insurance policy

On the other hand, whole life, universal life, and other permanent life insurance policies are designed to cover you for your entire life and can accumulate cash value over time. This cash value can be accessed in several ways, each with its own pros and cons. Here are some options for withdrawing cash from a life insurance policy:

Withdraw your entire cash value

If you have a whole life policy and need money, you can cash it out entirely to get all the cash value you've built up. However, this option requires surrendering your policy, which means your coverage will end, and your loved ones will no longer receive a death benefit. Additionally, you'll likely have to pay "surrender charges" and income taxes on the withdrawn amount.

Make a partial withdrawal

Another option is to take out some but not all of the cash value of your life insurance policy. The benefit of this option is that you don't have to surrender your policy, so your loved ones will still receive a death benefit, although it will likely be smaller than originally intended. It's important to check if the money you withdraw will be taxable.

Borrow money from your life insurance

If you've 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 borrowed amount, but the insurance company will deduct interest payments from your cash value balance. The interest rate on these loans can be lower than other options like 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 die before repaying the loan, the balance and interest will be subtracted from the death benefit.

Surrender the policy

You can also choose to surrender or cancel your policy entirely and receive the "surrender value," which is the cash value minus any fees. This option will result in the loss of your coverage, and your beneficiaries won't receive a death benefit. Depending on how long you've had the policy, there may be a penalty for early surrender, known as a surrender charge. If your payout exceeds the premiums you paid, you will likely owe income tax on that gain. Surrendering your policy is generally not recommended unless you're certain your beneficiaries no longer need the life insurance payout.

Borrowing from a life insurance policy

When borrowing from a life insurance policy, there is no approval process or credit check, and the money can be used for anything. The loan is also not recognised as income by the IRS, so it remains tax-free as long as the policy stays active. However, it is important to pay the loan back in a timely manner, as interest is added to the balance and can cause the policy to lapse if left unpaid. If the policy lapses, taxes may be owed on the borrowed amount. Additionally, if the insured person passes away before the loan is repaid, the loan amount and any interest will be deducted from the death benefit, reducing the amount received by beneficiaries.

The amount that can be borrowed against a life insurance policy depends on the insurer and the cash value of the policy. Most companies allow borrowing of up to 90% of the policy's cash value. It is important to note that borrowing from a life insurance policy can reduce the death benefit and increase the risk of policy lapse if the loan is not repaid. Therefore, it is crucial to consider the pros and cons carefully before taking out a loan against a life insurance policy.

Surrendering a life insurance policy

When a policy is surrendered, you lose coverage and are no longer responsible for paying insurance premiums. You may have to pay surrender fees for cancelling your coverage early, which will be deducted from any cash value your policy has or paid out of pocket if you have a term policy. You may also have to pay taxes on the surrender value if earnings exceed the amount you've paid into the policy.

Pros

• Easy and fast: Surrendering your policy is a simple and quick process.
• Get some money back: Surrendering your policy means you'll get some money back, which is better than getting nothing.

Cons

• Minimal return: You'll only get one offer from the insurance company, and their goal is to give you as little money as possible.
• Surrender fees: These can be up to 10-35% of the proceeds you'll get, depending on when you surrender the policy.
• Limited options: The insurance company will give you a take-it-or-leave-it offer, with no room to negotiate.

Before surrendering your life insurance policy, consider other options such as borrowing against your 401(k) plan, taking out a home equity loan, or selling your insurance policy.

Selling a life insurance policy

Selling your life insurance policy is a way to get cash by exchanging your life insurance coverage. This is done through a secondary market where you can sell your policy to a life settlement provider, who will then pay you a portion of your policy's value. The life settlement company will then take over paying your premiums and will receive the death benefit when you die.

There are several reasons why someone might consider selling their life insurance policy. Some common reasons include:

• No longer being able to afford the premiums after retirement or job loss.
• Increased expenses, leading to less disposable income.
• Needing cash to cover a large, unexpected expense.
• Starting to save for long-term care or medical bills.
• No longer needing the policy because your children and other dependents are now grown and financially independent.

How to sell your life insurance policy

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

• Application: Complete an application for each life insurance settlement from which you want to solicit offers. As part of the application process, you must grant the settlement company permission to obtain information about your policy and health.
• Documentation: Once you have submitted your application, the settlement company underwriters will gather information about your policy and your medical records.
• Appraisal: The underwriters will determine the market value of your life insurance policy by considering its value and your health. They will also look for signs of fraud.
• Offer: If your policy is deemed suitable for purchase, the settlement company will make an offer, which you can accept or decline. It is recommended to compare offers from multiple companies before making a decision.
• Closing: If you accept the offer, the settlement provider will send a closing package for you to review and sign. Once the documents are returned, your insurance provider will be notified of the transaction, and you will receive the settlement funds.

The amount of money you can get for your life insurance policy depends on several factors, including your policy's premiums, death benefit, your age, and health condition. According to the Life Insurance Settlement Association (LISA), the average life settlement is 20% of the policy's face value.

What to consider before selling your life insurance policy

Before selling your life insurance policy, it is important to consider the broader impact of such a decision. Some things to keep in mind include:

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

Tax consequences of selling your life insurance policy

When you sell a life insurance policy, a portion of the settlement may be considered taxable income. The taxed amount and tax rates will depend on the amount of the settlement, the premiums paid, and the cash value of the policy. It is recommended to consult a tax professional to understand the specific tax consequences of selling your policy.

Partial withdrawal from a life insurance policy

A life insurance policy owner can make a partial withdrawal from a permanent life policy, and it is usually not subject to income taxes as long as it's not more than the amount paid into the policy. However, the death benefit will likely be reduced, and this reduction may be greater than the amount withdrawn, depending on the specific terms of the policy.

If the policy owner withdraws funds from the cash value portion of the policy, they may not have to pay taxes on all of these funds. This is because the portion of the withdrawal that is considered a return of premium will not be taxable. For example, if the policy owner has paid a total of $20,000 in premiums into the policy and has a total of $25,000 in total cash value, they can decide to withdraw $23,000, and only $3,000 of that amount will be taxable. If the policy owner withdraws less than what they have paid into the policy, they will not be taxed at all on the withdrawal.

It is important to note that a partial withdrawal of a life insurance policy will lower the cash value of that policy. Although it is not typically required that these funds be repaid, if the insured dies while there is still an unpaid cash value balance, the amount of that unpaid balance will be charged against the death benefit paid out to the policy's beneficiary.

There may also be additional costs when taking a partial withdrawal, such as processing and administrative fees from the life insurance company. It is important to be aware of all potential charges before making any type of withdrawal from a life insurance policy.

Withdrawing cash from a life insurance policy can be a fast and easy way to get cash for a purchase, such as a car, for retirement income, or to help cover costs temporarily if you lose your job. However, it is important to consider the potential impact on the death benefit for your beneficiaries and any taxes or fees that may apply.

Frequently asked questions