A life insurance policy is basically something you buy that passes the money to your family if you pass away. The way it works is you select the coverage best suited for your needs, make monthly or annual payments, and if you pass away, the insurance company gives your beneficiaries the death benefit.
If you’re in a dire financial situation and are thinking about cashing out your life insurance policy, there are a few ways you can do that depending on what policy you have. You can cash out permanent life insurance policies that have a cash value component, but this will lower the payout to your beneficiaries in the event of your death, so think about this option as a last resort.
Typical life insurance policies and their differences:
- Permanent life insurance – This policy doesn’t expire, as long as you pay your premiums. Some permanent life insurance policies have a cash value component, meaning the insurance company places a portion of your monthly or annual payments in a cash fund. This cash fund can earn interest as it grows.
- Term life insurance – This policy covers you for a specific period of time, most likely for 10 to 20 years. Once the policy expires, you’ll have to extend it or get new coverage. There’s usually no cash value component associated with term life insurance.
A typical life insurance policy has a certain level of premium, which means the company will provide you coverage as long as you pay the policy in full. As an insured, if you die while the policy is active, the benefit would be paid to the named primary beneficiaries. But the real question is, can you cash out your life insurance? Of course, you can.
Ways to cash out your life insurance policy
Withdraw from your life insurance policy
Building up the cash value component of your life insurance policy takes years. But if your life insurance policy has a large pool of cash, you’ll most likely be able to withdraw part of it. Keep in mind that taxes may be due on the amount of cash you withdraw from your policy, so speak with a tax professional to know what to expect.
Take out a loan against your life insurance policy
This can be risky because if you don’t pay back the loan, the amount will be taken from the death benefit. Also, your insurer will probably cancel your life insurance policy if there is no more cash value in it. But, if you use a loan to take cash out of your life insurance policy, and you pay it back, the entire death benefit will remain intact. Taking a loan against your life insurance policy is usually easier than getting a loan from somewhere else because you won’t get your credit score checked.
Surrender your life insurance policy
By taking the cash out of your life insurance policy, you’ll forfeit the policy as a whole. In this case, your beneficiaries won’t receive a death benefit. Also, don’t expect to get the full cash value because there are fees involved in surrendering your policy, and you may even owe income tax if the payout is larger than the premium. Consider this option only if you are sure you don’t need life insurance anymore.
Cancel your life insurance policy
You might be able to keep the cash value accrued if you cancel your permanent life insurance policy. Not all policies let you do this though, so make sure your policy allows it. If you choose this option, don’t expect to get your premium money back.
Consider using your life insurance policy’s living benefits
Permanent life insurance policies often have options to cash out, even without the event of a death. However, most policies won’t cover the full cost of long-term care, but you can use this option as a safety net. Here are some ways you may qualify for these benefits:
- If you’re terminally ill and expected to live for less than a year or two, you can cash out a life insurance policy.
- You’ll be able to cash out your life insurance policy to pay for long-term medical care.
- It may be possible to cash out your life insurance policy if you have a chronic illness that makes doing basic things virtually impossible.
Sell your life insurance policy to a third party
Unfortunately, third parties tend to take advantage of people who are desperate for money. This isn’t a highly recommended option because the return is usually very low. Selling your policy also means that your beneficiaries will no longer have access to the death benefit if you pass away. Also, selling your life insurance policies to a third party can be subject to extra hidden fees, but it’s definitely something to consider if you’re in a dire situation and need cash fast.
Use the cash value to cover your life insurance policy premiums
Did you lose your job or are strapped for cash? If your life insurance policy has cash accumulated, you can use that cash to pay for your premiums, but you’re going to need to ask your insurer for permission. Doing so will ensure that your policy stays in effect.
Frequently asked questions
When should I cash out my life insurance policy?
It depends from person to person. If you’re sure your fortune can cover your family’s needs if you pass away, then cashing out might be the right choice. But if you’re strapped for cash in the short term, try to exhaust every other possible avenue before cashing out your life insurance policy.
If I cash out my life insurance policy, do I have to pay taxes?
The IRS taxes investment growth. Say your policy’s cash value is $130,000 after paying $60,000 in premiums. In this case, the taxable amount would be $70,000. Before cashing out, know how much of the cash you’ll have to pay in taxes.
How long does it take for your life insurance policy to gain cash value?
It varies, but you’ll most likely have to pay your premiums for at least 2 years before the policy accrues some cash value.