Can I Cash in a Life Insurance Policy- If you’re facing financial constraints, you might be curious about the possibility of cashing in your life insurance policy. The ability to do so largely depends on the specific type of policy you possess. However, deciding to cash out your life insurance is a big decision that requires careful consideration.
By the end of this article, you’ll gain insight into which policies hold cash value, the optimal timing for cashing in while you’re alive, and alternative approaches to address financial difficulties. keep reading to know all about it.
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Can You Cash Out a Life Insurance Policy?
Yes, you can cash in a life insurance policy, but it’s only possible with a permanent policy. Well, it also depends on the type of policy you have. Let’s delve into the details and understand the differences between two key types of life insurance: term life and permanent life insurance.
Term Life Insurance
This type of policy provides coverage for a specific period, typically 10, 15, or 20 years. Once the term is up, the policy expires, and you stop paying premiums. To continue having life insurance, you’ll need to either extend the original policy or look for new coverage.
Permanent Life Insurance
Unlike term life, permanent life insurance never expires as long as you keep paying the premiums. If you have a “whole life” or “universal life” policy, it may even accumulate cash value. Each time you make a payment, a portion goes into a cash fund, which grows over time with added interest.
It’s important to note that term life policies don’t have any cash value, but permanent policies might. If you hold a permanent life insurance policy with cash value, then yes, you can cash out a portion of it. If this seems a bit confusing, don’t worry. We’ll break it down further.
Remember: You can’t cash out the entire death benefit amount. For instance, if your policy has a death benefit of $200,000, you won’t be able to cash out the full $200,000. Barring any special circumstances (which we’ll cover later), you can only access the cash that has accumulated over the years.
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How to Obtain Cash from a Life Insurance Policy
As mentioned earlier, term life policies don’t offer cash value. However, with permanent policies like whole life or universal life, there may be cash available. Here are five ways to access cash from your life insurance policy.
Withdraw from Your Policy
If you’ve been paying premiums for a while and have accumulated a significant cash value, you can make a partial withdrawal. Let’s say you have $50,000 in cash value and need $25,000. Simply contact your insurance company and inquire, “Can I withdraw money from my life insurance?” Chances are, they’ll say yes.
Here’s what happens in this scenario:
1. The insurer sends you a $25,000 check.
2. Your insurance policy remains in effect, meaning beneficiaries will still receive a death benefit if you pass away.
3. However, the death benefit received by beneficiaries will be $25,000 less than the original policy’s face value. So, instead of $200,000, they’ll receive $175,000.
Keep in mind that taxes may be due on the amount withdrawn. It’s crucial to consult a tax professional before cashing out any portion of your life insurance policy.
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Borrow From Your Policy
In some cases, you can take a loan from your life insurance policy. The borrowed amount is typically not subject to taxes, but you’ll need to pay interest on it, similar to a loan from an external lender.
It’s important to note that a life insurance loan works differently from a traditional bank loan. You’re not obligated to repay the loan, but you must make interest payments.
If you fail to do so, the interest owed will be deducted from the cash value. Once the cash value is depleted, the insurance company may cancel the policy due to non-payment.
If you fully repay the loan, your beneficiaries will receive the full death benefit upon your passing. However, if there’s a balance remaining at the time of your death, that amount, along with the accrued interest, will be subtracted from the death benefit paid to beneficiaries.
Surrender Your Policy
Let’s Say you’ve paid premiums on a permanent life insurance policy for 30 years. Initially, you purchased the policy to secure your business partner’s interests, but now you’ve sold the business and no longer require the coverage. In such a case, you can opt to surrender the policy and receive the cash surrender value.
However, surrendering the policy means you no longer have life insurance coverage, and beneficiaries won’t receive a death benefit upon your passing. Additionally, you may be subject to a surrender charge, and taxes will likely be owed on the cashed-out amount.
Take Advantage of Living Benefits
Many permanent life insurance policies offer the opportunity to cash out prior to death under certain circumstances. Here are a few examples:
Terminal Illness: If you’re expected to live fewer than 12 months, you can cash in your life insurance policy to cover various expenses, including living costs and healthcare.
Long-Term Care: When facing the need for long-term healthcare, you can tap into your life insurance policy to help finance the necessary care.
Chronic Illness: Suppose you have an illness that hinders activities like bathing, eating, or dressing, but you can still reside in your home. In that case, cashing out your permanent life policy can assist in covering the costs of care.
If you’re unsure whether your policy offers these “living benefits,” contact your insurance company to inquire. Even if the policy doesn’t cover the entire cost of long-term care, it can still provide valuable assistance.
Remember: If you qualify for Medicaid assistance, it’s advisable to postpone cashing in life insurance benefits until you have a clear understanding of how it will impact your potential benefits.
Apply Cash Value to Policy Premiums
If you’re struggling to make premium payments, utilizing the cash value as a short-term solution may help. As long as you’ve accumulated enough cash in the policy, you can request that the insurer use that cash to cover your premium payments. For instance, if you’ve lost your job but want to maintain coverage until you find new employment, using the accrued cash for premium payments alleviates some financial stress.
However, keep in mind that once the policy’s cash value is depleted, you’ll need to resume making payments; otherwise, the insurer may cancel the life insurance policy.
Do You Pay Taxes on a Life Insurance Cash-Out?
When considering cashing out a life insurance policy, taxes should be a top consideration. To illustrate this point, let’s revisit the scenario of someone who purchased a policy solely to protect their business partner’s interests.
Suppose this individual paid $40,000 in premiums and ended up with $120,000 in cash value. Upon surrendering the policy, they receive the cash value. However, the IRS considers $80,000 of that cash taxable, representing the growth on the investment.
To make an informed decision before withdrawing cash from your life insurance policy, it’s crucial to determine the portion of the cash that will be allocated to taxes.
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When Should You Cash Out Your Life Insurance Policy?
There are a few situations where cashing out your life insurance policy may be warranted. For example:
Amassed Wealth: If you’ve accumulated a significant amount and have no concerns about your beneficiaries’ financial security after your passing, surrendering the policy and taking the cash value might make sense.
Investment Strategy Change: Let’s say you initially opted for an indexed universal life policy because it was tied to the stock market. However, your investment goals have changed, and you’d prefer to utilize the funds invested in premiums for other types of investments. In this case, cashing out the life insurance policy may be a financially viable option.
A word of caution: Selling a permanent life insurance policy to a third party is never recommended, regardless of how quickly
they promise cash. These companies often prey on individuals in desperate need of money and offer significantly lower amounts. Furthermore, once the policy is sold, the third-party company becomes the beneficiary, leaving the original beneficiaries without any benefits.