Cashing Out a Life Insurance Policy: How Does It Work?

What Does Cashing Out a Life Insurance Policy Mean? 

Cashing out a life insurance policy refers to the process of a policyholder retrieving the cash value aspect of their policy while they’re still living.

Policyholders with certain types of permanent life insurance not only pay monthly premiums toward a death benefit for their beneficiaries but a portion of those premiums are invested into a cash value component that policyholders can access while still living. If the policyholder decides they want to access these funds, they may choose to cash out the policy, or a portion of the policy.

Why You Might Consider Cashing Out 

There are many reasons you may consider getting cash out of your life insurance policy. Finding yourself in a situation where you either need money right away or no longer have a need for your permanent life insurance policy can be reasons to consider cashing out. 

• You need to access cash immediately. Regardless of the situation, if you need cash immediately, cashing out your life insurance policy may be a great way to get funds immediately. 
• You would like supplemental income. Sometimes we all need a little extra to get us to the next paycheck. Taking a loan or cashing out your life insurance could help.
• You no longer need life insurance.  If you have saved enough money for funeral costs, no longer have any debt to pay off should you die, or have no beneficiary to give a death benefit to, you may no longer need life insurance. 
• You have multiple life insurance policies. Having multiple life insurance policies is not bad, but may not be necessary depending on your needs. 
• You are switching up your investments. If you purchased life insurance as part of an investment strategy and are looking to change how you invest, you may no longer need it. 

How Does Cashing Out Life Insurance Work? 

	How much is paid?	When is it paid?	What happens to the policy?
Surrender the policy	Total cash value minus fees and taxes	Upon cancellation	Policy canceled
Policy loan	Loan amount that is less than death benefit	When you request a loan	Policy still active; cash value shrinks accordingly
Policy withdrawals	Cash value	When you request a withdrawal	Policy still active; cash value shrinks accordingly
Activate riders	Cost of covered expenses	Upon expenses incurred	Policy still active; cash value shrinks accordingly
Sell the policy	Price agreed upon	When sold	You are covered, but the buyer receives your death benefit

You can withdraw some or all of your life insurance’s accumulated cash value when you cash it in. How you do this depends on whether you want to keep the policy or if you are ready to part with it altogether. The best way to cash in a life insurance policy depends on several factors, including whether you want to keep the policy and how much money you need.

Eligibility to Cash Out 

As long as you’ve accumulated enough cash value in your policy, you should be eligible for cashing out a life insurance policy, though how much that is depends on the policy terms. You will be unable to borrow a portion of or completely cash out the policy if there is no cash value. You also cannot cash out on a term life insurance policy, unless it is a convertible term. 

How to Get Cash Out of Your Life Insurance 

There are a couple of different ways to cash out your life insurance policy. Be sure to consider all options as you decide what is best for your unique situation. 

Get a Policy Loan 

Life insurance companies typically allow policyholders to borrow against their accumulated cash value. As opposed to other loans, these loans don’t have to be repaid. However, these loans accumulate interest charges, directly affecting your death benefit since any money that hasn’t been repaid when the policyholder dies will be subtracted from the death benefit. As a result, your beneficiary will get less death benefit than they should. 

Getting a policy loan is an excellent option for those who want to keep their policy in force but need the cash now. 

How Much Money Could You Get? 

You can borrow up to the amount of your accumulated cash value. For example, if your accumulated cash value is $100,000 then you could ask for a loan for any amount up to $100,000. Most policies will have interest that will accrue, and taxes may come into play. 

What Happens If You Do Not Repay the Loan? 

If you do not repay the loan and interest fees, the death benefit that is paid to your beneficiaries will be reduced by that amount. In the example above, if you borrowed $100,000 and had a total of $2,000 in interest and did not pay it back, the death benefit would be reduced by $102,000. 

How to Get a Policy Loan 

Getting a policy loan is quite simple.

• Request the loan: Call your agent or company and ask for a loan against your life insurance policy.
• Receive a check: Your company will send you a check, and you can use the money as you please.
• Repayment: Repay your loan, or at minimum the interest, to ensure your death benefit is not reduced. 

Withdraw From Your Policy’s Cash Value 

As an alternative to a loan, it is also possible to withdraw cash from your policy if you wish. There’s nothing to repay because you’re just taking money from the cash value, not borrowing it like a loan. However, your loved ones will receive a lower death benefit as a result. Partial surrender charges may or may not be assessed by your insurance company. However, you don’t usually have to pay any taxes in most situations.

Withdrawing money from your permanent life insurance policy keeps your policy intact and prevents having to pay it back, so if you have enough accumulated cash value this may be an excellent option for you.

How Much Money Could You Get? 

In general, withdrawals from a policy are tax-free up to the amount you have already paid in premiums. Taxes typically apply to anything over your premiums already paid.

How to Withdraw From Your Policy’s Cash Value 

Withdrawing cash from your policy is simple.

• Contact the insurer: Contact your insurance company or agent to request a withdrawal, up to the available cash value in your policy.
• Receive the money: Receive the money and use it for whatever you like.
• Repayment: You do not need to repay and your policy stays active, but remember the death benefit may be reduced. 

Activate Your Rider(s) 

When you initially purchased your life insurance policy, you likely were offered additional riders to provide more benefits. These riders are meant to give you your death benefit early, should you be faced with a difficult diagnosis or situation that applies to those riders. For many riders, you can access up to 50% of your death benefit. 

• Basic living benefit rider: If you are diagnosed with a terminal illness and have the living benefit rider on your life insurance policy, you can borrow up to half of your death benefit to pay for medical expenses or other financial hardships caused by the illness. 
• Chronic illness rider: Chronic illness can be a debilitating thing for many people, and it can cause you to have a tough time doing basic daily activities. If you have a chronic illness rider, you can cash out money from your policy, which will reduce your death benefit.
• Long-term care rider: Healthcare expenses can be burdensome these days, and long-term care is no exception. In some life insurance policies, you can cash in a long-term care rider to pay for assisted living expenses. 
• Accelerated death rider: A life insurance policy that includes an accelerated death benefit allows you to access a portion or the entire death benefit while still living. When you are terminally ill or have a qualifying medical condition, accelerated death benefit riders help pay for your medical care.

How to Activate Your Policy’s Riders 

To activate your life insurance policy, riders do the following:

• Ensure you qualify: To qualify for one of the riders above, you must have a qualifying medical condition diagnosed by a physician. Or you must require long-term care.
• Contact your insurer: You simply contact your insurance company and will have to provide them with documentation for the rider to be activated.

Surrender Your Policy 

Life insurance policies can be surrendered by canceling them and receiving their surrender value in return. Essentially, this is the cash value accumulated minus surrender charges. Once you pass away, your named beneficiary or beneficiaries will no longer receive death benefits from your policy. You may owe capital gains tax on the difference if your cash value exceeds your premiums.

Remember, your policy will cease to exist if you surrender it, so your family will be left with no death benefit if you die. If you no longer need a death benefit or have multiple life insurance policies, this could be an option for you.

How Much Money Could You Get? 

When a policyholder surrenders or terminates a life insurance policy voluntarily, they receive the cash surrender value less any fees charged by the carrier. The carrier will also subtract any loans or withdrawals you have made against the policy. The insurance carrier can tell you if they charge any surrender fees. 

How to Surrender Your Policy 

Surrendering your permanent life insurance policy will be easy.

• Contact your insurer: Simply call your insurer and explain that you would like to cancel or surrender your policy.
• Receive funds: After the insurance company calculates your surrender value, removing any debts or fees, you will be paid.

Sell Your Policy 

You can sell your permanent life insurance policy, but understand this should only be done in extreme cases. You can sell all or part of your policy to a third party. They will pay you more than its face value but less than the death benefit. Then, when you die, the purchaser receives your death benefit. It is a risky way to cash out your life insurance because your beneficiaries no longer receive a death benefit, and your circumstances could change in the future. 

How Much Money Could You Get? 

The amount you will receive if you sell your policy will be agreed upon by you and the purchaser but will be less than your death benefit. Typically, it is around 50-75% of the death benefit. The money you receive should not be taxable as income, but you may need to pay a capital gains tax on any gains from the sale. 

How to Sell Your Policy 

Selling your policy can be quite easy.

• Find a buyer: Search for a buyer or broker that purchases life insurance policies. There are typically marketplaces that have a list of potential buyers.
• Sign it over: You will agree to the terms, complete the paperwork, and sign your policy over to the buyer. 
• Receive payment: You will then receive a lump sum payment.

Should You Cash Out Your Life Insurance? 

You might want to consider cashing out your life insurance policy depending on your financial situation. For example, if you have multiple life insurance policies you might have a need for them all. You may be able to get back some of the premiums you paid by cashing out your existing coverage if you want to switch to a cheaper policy. If you are enduring financial hardship, it may be a way to quickly get some cash. Be sure to consider the following. 

How Much Cash Value Have You Built? 

You first have to determine if you are even eligible to cash out your life insurance. If your policy is relatively new, you likely will not have enough cash value to make it worth pulling some cash out, especially after fees and possible taxes.

Depending on how much you cash out of the policy, you might be required to pay taxes. In the event that you receive a greater amount than the premiums you paid into the policy, you’ll have to pay taxes on the excess.

Do You Still Need Your Policy? 

Most people need some sort of death benefit so that their loved ones can, at a minimum, have a funeral or pay for debts and any other end-of-life costs. However, if you don’t have any beneficiaries, your debt is paid off, or you have another policy, you may not need your life insurance policy. 

Be aware that if you do need your policy and take out a loan without paying it back, your death benefit will be reduced by the amount you owe, plus interest.

Would You Need a New Life Insurance Policy In the Future? 

Surrendering your policy, or letting it lapse, can cause issues in the future if you pass away and leave your loved ones with no benefit. When you have no life insurance and want to purchase a policy, you have to reapply and are subject to underwriting. This could include medical questions, a physical, and even bloodwork. If you have underlying conditions it could affect your eligibility and premium. 

Will This Impact Your Taxes and/or Medicaid Eligibility? 

Your policy allows you to withdraw money tax-free, but only up to the amount of premiums you’ve already paid. You are usually required to pay taxes on anything above what you have already paid in premiums.

When you withdraw money from your policy, it eats away at the benefit your beneficiaries receive when you die. A tax bill could also be in your future. Be sure to consider all tax implications when considering cashing out your policy.

Consider Alternatives to Cashing Out 

Perhaps instead of using a life insurance policy as a way to get cash fast, you can consider some other options. While they may be a little more time-consuming, they could save headaches in the long run. 

• Getting a personal loan: A personal loan can be a great option if you have a bigger purchase to make or want to consolidate debt. It is especially beneficial if you know you will be able to pay it off in the future. 
• Utilizing credit card perks: Credit cards these days have some unbelievable benefits. Many offer an introductory 0% APR on purchases. Additionally, many offer cash back on purchases and you can opt to receive that as a check or direct deposit. A no-interest credit card is a great way to obtain a loan if you know you can pay it back by the end of the promotional period.
• Getting a home equity loan: You can borrow against a portion of your home’s equity at a fixed interest rate with a home equity loan. To calculate your home’s equity, subtract the balance of your mortgage from the current market value. Large purchases, home renovations, and emergency expenses are some of the common uses for a home equity loan. Typically, the interest rate on a home equity loan will be lower than on a personal loan. 

Putting It All Together 

Cashing out a life insurance policy gives you several options, and it is important to understand what each one entails. Consider your long-term financial goals before you draw on the cash value of a life insurance policy. Withdrawal, or take a small loan from your policy if you only need a small amount. You may be eligible for living benefits if you need a higher amount, or you may be able to surrender or sell your policy if you need a much larger amount.