What Happens When You Cash-Out Your Life Insurance Policy
Before you think about cashing in your life insurance policy you may want to see if you can sell the policy. It could have much more value than just cashing it in.
Learn More: Sell your life insurance policy for cash
Cashing out your life insurance policy is often a difficult decision, compounded by the demands of daily responsibilities and economic stress. In those situations, when cash is tight and expenses continue to mount, your life insurance policy may be a financial resource.
This scenario is not, however, free of liabilities: It may satisfy your immediate concerns, but it can also undermine your long-term goals and the financial stability of your family’s future needs and expectations.
Still, if cashing out your life insurance policy is your only option – if you have no other practical way to pay bills and survive during a prolonged period of unemployment, illness or some other hardship – the cash-value of your life insurance policy may be your most important means of rescue from an otherwise tumultuous sea of debt.
Knowing your options, and the consequences regarding each decision will give you a better sense of what happens when you cash-out your life insurance policy.
Option One: Getting Cash
Whether you have whole life or universal life insurance, either policy builds cash via a combination of premiums and earnings. This money goes into a cash-accumulation account within the particular policy you hold.
A cash-value life insurance policy gives you access to these reserves via loans, withdrawals, or surrender (in part or whole) of the policy. You may also sell your policy – this option is a life settlement – for whatever the cash amount is.
Depending on how you use this money, despite the financial difficulties you may face, there can be drawbacks to accessing this or that life insurance account.
Option Two: Cash Withdrawals from Your Life Insurance Policy
In most cases, you can withdraw specified quantities of cash from your life insurance policy. The amounts vary, according to the type of life insurance you have and the insurer that holds your policy.
The principal strength of cash-value withdrawals is their non-taxable status, up to your policy basis, provided your life insurance policy is not a modified endowment contract (MEC).
Again, this option is not without its share of complications, which include: Withdrawals that reduce your death benefit, and lower the amount of money you may need to supplement your income, meet business expenses or build wealth; withdrawals done in the first 15 years of the policy, which lower the death benefit and subject the withdrawn money to tax penalties; withdrawals that are also taxable because they are greater than the basis of your life insurance policy; withdrawals that lower the cash surrender value of your policy, thereby increasing your premiums (to preserve the same death benefit); and withdrawals that are taxable under the same rules as annuities or income, if you are younger than 59 (59.5, to be exact) during the withdrawal.
Option Three: Loans Involving Your Life Insurance Policy
With this option, many cash-value life insurance policies allow you to borrow money in the form of collateral. For example: Based on the terms of your policy, the loan may accrue interest – the rates vary – but you do not have to qualify to receive this loan.
The amount of available cash you can use is the result of two things, the cash accumulation account and the terms of your life insurance policy.
One key advantage of this option, conditioned on the assumption you do not plan to borrow money from a MEC policy, is that you do not have to make monthly payments on the loan, despite whatever interest may accrue to the overall balance of the loan.
The drawback to this option is that it reduces your life insurance policy’s death benefit, and, as the loan accrues interest and decreases your cash value, the policy can lapse if you do not pay the minimal premiums to maintain the death benefit.
Option Four: Surrendering Your Life Insurance Policy
In this circumstance, you can cancel your life insurance policy – you can surrender it – and use the cash however you like. But, should you cancel the policy within the early years of owning it, you will probably have to pay surrender fees that will lower the cash value you receive.
Again, the rules vary with each life insurance company. You may, therefore, have to pay income tax or other taxes associated with surrendering your policy. You also forfeit the death benefit connected to your life insurance policy.
Option Five: Choosing a Life Settlement
This option is straightforward insofar as you would sell your life insurance policy to a person or a life-settlement company for cash. In return, the buyer would now own the policy and collect any death benefits.
You must be 65 and in most cases 70 or older to exercise this option, with a less than favorable life expectancy, with a death benefit no less than $100,000. Having a universal life policy is ideal, as well, vs whole life.
Conclusion: Know Your Options and Do Your Due Diligence
It is crucial to evaluate your options, to judge the merits and weaknesses of each choice, so you can make the right decision about cashing out your life insurance policy.
Speak with an experience life insurance agent, who can answer your questions and address your concerns involving this decision. Local Life Agents is here when you need us and offer you advice if you need help.