Life Insurance Cash Out: What You Need To Know

Life insurance is primarily designed to protect your family financially after you are gone. However, permanent life insurance policies, such as whole life or universal life, also accumulate cash value that you can access during your lifetime. This cash value can be used to cover the cost of a medical emergency or to help pay a child's college tuition, for example.

There are four main ways to access the cash value in your life insurance policy: withdrawal, loan, surrender, and sale. Withdrawing money from your life insurance policy is usually distributed as a lump sum or in payments. You can also take a loan from your insurer, using your policy as collateral. Surrendering your insurance policy means cancelling it and taking the surrender value cash payment. Finally, you can sell your policy to a third party through a process known as a life settlement.

It is important to consider the pros and cons of each option before deciding to access the cash value in your life insurance policy. For example, withdrawing or borrowing cash from your policy may reduce your death benefit, while surrendering your policy means giving up your life insurance coverage altogether. Additionally, you may have to pay taxes on any gains made from the cash value of your policy.

Withdrawing cash from a life insurance policy

When considering withdrawing cash from a permanent life insurance policy, it is important to weigh the pros and cons of the various methods available:

Withdrawal

Withdrawing cash from your permanent life insurance policy is usually an option, and the withdrawn amount is often not subject to income taxes if it does not exceed the total premiums paid into the policy. However, a potential disadvantage is that your death benefit may be reduced, and this reduction may be greater than the amount withdrawn, depending on the specific terms of your policy. Additionally, withdrawals above your policy basis may be subject to taxation. It is important to consult with your agent or insurance company to understand how withdrawals work for your specific policy.

Loan

Taking a loan from your life insurance policy is another option. The insurer lends you money, using your policy as collateral. Life insurance loans typically have lower interest rates compared to personal loans or home equity loans, and there is no loan application or credit check required. You are not obligated to repay the loan, but if you choose not to, the outstanding loan balance, including any interest, will be deducted from your death benefit. It is important to monitor the loan balance to ensure it does not accrue interest and reduce your cash value, which could cause the policy to lapse.

Surrender

Surrendering your life insurance policy means cancelling it entirely and receiving the surrender value cash payment. However, this option comes with several drawbacks. You will no longer have life insurance coverage, and the cash you receive will be reduced by any surrender fees, which can be significant, especially for newer policies. Additionally, surrendering a policy may result in tax implications, and your beneficiaries will not receive a death benefit.

Sale

Selling your life insurance policy to a third party, known as a life settlement, is another way to access cash. This option typically provides a larger sum than surrendering the policy, but it also has its downsides. You give up control of the death benefit, and the new policy owner gains access to your medical records. The life settlement industry is marginally regulated, making it challenging to determine the fair price for your policy. Additionally, commissions and fees can reduce the net amount you receive.

Before deciding to withdraw cash from a life insurance policy, it is crucial to carefully consider the potential consequences and explore alternative options, such as borrowing against a 401(k) or taking out a home equity loan. The decision should align with your overall financial plan and consider the impact on your beneficiaries.

Borrowing from a life insurance policy

Eligibility

Borrowing against your life insurance policy is only possible if you have a permanent life insurance policy, such as whole life insurance or universal life insurance. These policies are more expensive than term life insurance but do not have an expiration date and can build cash value over time. This cash value can be borrowed against, but it usually takes a few years for the policy to accumulate enough value to borrow a significant amount.

Process

The process of borrowing against your life insurance policy is straightforward. You can request a loan from your life insurance company for any reason, and there is no approval process or credit check. The only requirement is that you have sufficient cash value in your policy, and the minimum amount required varies by insurer. The interest rates on these loans are generally lower than personal loans or credit cards, ranging from 5% to 8%.

Repayment

While there is no strict repayment schedule for life insurance loans, it is in your best interest to pay back the loan as soon as possible. The longer the loan is left unpaid, the more interest will accumulate. If the amount owed exceeds the cash value of your policy, it may lapse, and you will be left without insurance coverage. Additionally, if you die before repaying the loan, the amount owed, including interest, will be deducted from the death benefit paid to your beneficiaries.

Pros and Cons

One of the biggest advantages of borrowing against your life insurance policy is the lack of credit and tax implications. The loan does not affect your credit score, and you are not tied to a strict repayment schedule. Additionally, the interest rates are typically lower than other loan options. However, there are also disadvantages to consider. If you do not repay the loan, it will reduce the death benefit your beneficiaries will receive. The loan and accumulating interest can also cause your policy to lapse if you do not keep up with premium payments.

Alternatives

Before borrowing against 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 if allowed. These alternatives may have their own pros and cons, so be sure to carefully consider your current financial circumstances before making a decision.

Surrendering a life insurance policy

Surrendering your life insurance policy means that you are cancelling your policy in exchange for a cash payment. This is a permanent decision and will result in the termination of your coverage.

When you surrender your life insurance policy, you will receive the cash surrender value, which is the cash value of the policy minus any surrender fees and taxes. Surrender fees typically range from 10-35% and are usually higher in the early years of the policy.

Whole and Universal Life Insurance Policies

Whole and universal life insurance policies accrue cash value, making them the most likely option for surrender. Depending on the type and age of the policy, they may have accrued a significant amount of cash value.

Surrender Fees and Taxes

There are two main caveats to surrendering a life insurance policy. First, if your policy is not very old, you may incur surrender fees, which will reduce the amount of cash you receive. Second, the gain on your policy will be taxed as income. While death benefits are tax-exempt, the cash received from surrendering a policy is taxable.

When to Surrender a Life Insurance Policy

It is generally recommended to wait until after the surrender period is over before surrendering a life insurance policy, as this will help you avoid higher surrender charges and get more money. However, if the policy becomes unaffordable or you no longer need coverage, it may make sense to surrender the policy sooner.

Alternatives to Surrendering a Life Insurance Policy

It is important to consider alternative options before surrendering a life insurance policy, as this is a permanent decision that will result in the loss of coverage. Some alternatives include selling the policy, borrowing against a 401(k) plan, or taking out a home equity loan.

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 process called a life settlement. A life settlement is the sale of a life insurance policy to a third party, known as a life settlement provider. The owner of the life insurance policy sells the policy and receives an immediate payment in return.

The life settlement provider becomes the new owner of the life insurance policy and takes on the responsibility of paying any future premiums. In return, the provider will receive the death benefit when the person whose life is insured under the policy (the insured) dies.

Who can sell their life insurance policy?

To sell your life insurance policy, you must be both the policy's owner and the named insured. The policy must be individual life insurance, not group life insurance, and it typically needs to have a death benefit of at least $100,000. There may also be an age restriction, and in most cases, you need to be 65 or older.

It is impossible to predict exactly how much money you can make by selling your life insurance policy, as there is no standard formula. However, according to the Life Insurance Settlement Association (LISA), the average life settlement is 20% of the policy's face value.

The amount of money you can get depends primarily on four factors: your policy's premiums, the policy's death benefit, your age, and your health condition. The lower the premiums and the less time spent paying them, the more beneficial it is for the life settlement company.

How to sell your life insurance policy

• Application: Complete an application for each life insurance settlement from which you solicit offers. Grant the settlement company permission to obtain information about your policy and health, and provide any necessary disclosures and additional information or documentation.
• Documentation: Once you have submitted your application, the settlement company underwriters will gather information from your life insurance provider and your healthcare providers.
• Appraisal: Underwriters will determine the market value of your life insurance policy by considering its value and the opinion of medical experts regarding your health. They will also look for signs of fraud.
• Offer: If your policy is deemed suitable for purchase, the settlement company will extend 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 signed documents are returned, your insurance provider will be notified of the transaction, and you will receive the settlement funds.

From start to finish, the process of selling your life insurance policy typically takes between 60 and 120 days. The timing depends on how quickly third parties, such as your insurance company and healthcare providers, respond to requests for information.

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 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.
• A portion of the settlement may be considered taxable income. Consult a tax professional to understand the specific tax consequences.

Alternatives to selling your life insurance policy

• Use the cash value of the policy: Whole and universal life insurance policies have a cash value that you can withdraw from or borrow against. These actions will reduce your policy's death benefit unless you repay the money.
• Convert to a whole life insurance policy: Convertible term policies allow policy owners to convert to whole life insurance, which has the benefit of accumulating a cash value.
• Seek an accelerated death benefit: Some policies include a provision that allows the life insurance company to prepay some or all of the death benefit if the insured is diagnosed with a terminal illness.
• Change the beneficiary: You can change the beneficiary of your term or permanent life insurance policy as needed.
• Reduce the death benefit: Lowering the death benefit is a way to reduce the cost of life insurance.
• Replace your policy: Consider replacing your existing life insurance policy with a new one that better aligns with your financial goals.
• Surrender the policy: You can surrender a life insurance policy you no longer want, and many permanent life insurance policies have a cash surrender value. However, selling your policy will usually result in a higher payout than simply surrendering it.
• Stop making premium payments: You can choose to stop making premium payments and allow the policy to lapse, but this option provides no cash payout.

It is recommended to speak to a financial advisor or estate planning attorney before making a decision to ensure you understand the legal and financial implications for both you and your heirs.

Partial withdrawal from a life insurance policy

When you buy a permanent life insurance policy, a portion of the premiums you pay is set aside by the life insurance company in what is known as the cash value component of your policy. Over time, this cash value grows and can be accessed for various purposes.

A partial withdrawal from your life insurance policy is usually not subject to income taxes as long as it’s not more than the amount you’ve paid into the policy. However, your death benefit will likely be reduced, and that reduction may be greater than the amount you withdraw, depending on the specific terms of your policy. There may also be additional costs involved when taking a partial withdrawal, such as processing and administrative fees from the life insurance company.

If you need to access cash, there are several alternatives to withdrawing from your life insurance policy, including taking out a home equity loan, a personal loan, or a loan from your retirement account.

Frequently asked questions