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How to cash out your life insurance policy
If you’re tight on cash or simply don’t need as much coverage, we explore the 5 ways to get access to your funds early.
There are a few ways to access the cash from your permanent life insurance policy, from taking out loans to surrendering your policy completely. But if you still want or need insurance, be careful — depending on the option you choose, you run the risk of canceling your coverage or reducing the death benefit for your beneficiaries.
What is the cash surrender value?
Permanent policies contain an invested cash value component that grows over time. If you surrender your permanent policy, you might be able to collect some of the cash value — known as the “cash surrender value” or CSV.
The dollar figure you’ll get depends on how long you owned the policy. For example, if you cancel during the first few years of taking out a policy, you may not have built up enough cash value to collect. And if you cancel at a later stage, you’ll receive the cash value minus any fees, charges and loans.
Watch out for taxes!
The cash value grows on a tax deferred basis. Meaning that when you surrender your cash value, you’ll be responsible to pay taxes on the amount of interest you’ve earned. If you do decide to surrender your cash value, it would be best to discuss your situation with a tax advisor to ensure you fulfill all of your tax obligations.
How to use the cash value of your policy
There are five different ways to use the cash value of your life insurance policy to your advantage.
1. Borrowing from the cash value
A great feature of permanent life insurance is the option to borrow from the cash value of your policy. Most insurers require a minimum cash value before you can take out a loan, but after that you can borrow up to the full amount you’ve accumulated.
Low interest rates and flexible repayment terms are generally the perks of these policy loans. Since you’re essentially borrowing from yourself, there are usually no required monthly payments. However, even with the perks, your full loan needs to be paid back on time. Not paying back your full amount could result in penalties like:
- Reduced death benefit. If your loan isn’t repaid when your family tries to access your death benefits, they’ll end up with less money after the loan amount and interest are paid.
- Outstanding policy loans. The longer you wait to pay back your policy loan, the more interest it accumulates. This raises your loan value, and could exceed your policy’s cash value. If that happens, your policy will lapse.
As long as the amount of the loan doesn’t exceed the policy’s adjusted cost basis (ACB), the amount is not taxed. If the loan amount is greater than the ACB, the entire amount of the loan is taxable.
2. Cash value withdrawals
You may also have the option to just take money from the cash value of your policy. While it may seem obvious, keep in mind that because you aren’t repaying the amount you take from your cash value, it becomes permanently depleted. However, that may not be a bad thing. Make sure you review your policy closely, because in many cases if you don’t use your cash value while you’re alive, you’ll lose it.
Withdrawals that reduce your cash value may cause a reduction in the death benefit amount, reducing the payout to beneficiaries when you die.
When your withdrawal amount exceeds the ACB, your withdrawal becomes taxable. When the ACB reaches zero, the entire amount of your withdrawal is taxed.
3. Using your cash value as collateral for a loan
This is an indirect method of using your cash value. You essentially apply for a loan at some financial institution and assign the cash value of your life insurance policy as collateral. In this case, if you fail to repay the loan before you die, the loan will be payed back from the death benefit. This might help you get a more favorable loan interest rate. Some drawbacks of this option are:
- Reduced death benefit. If you can’t repay the loan, your beneficiaries will receive less money.
- Complicated to set up. It can be administratively intensive to coordinate this with both your lender and life insurance companies.
Loan advances can be received without paying tax. In some situations, the interest on the loan may even be deductible, like when loan proceeds are used towards generating business or property income.
4. Surrendering your policy
If you no longer need life insurance, you can surrender your policy and collect the cash. By doing this, you’ll cancel your coverage, and may run into these issues:
- Surrender fees. The cash value of your policy grows slowly, especially during the first few years. This option gives you cash value minus any surrender fees, which are much higher earlier on in the policy. Surrender too early, and the fees may eat up a large portion of your surrender value.
- Potential reduced payout. Surrendering a policy with an outstanding loan can drastically reduce the payout. Make sure to pay off your entire loan balance including interest before surrendering, so that you can get the most from your policy.
- No death benefit. Without an active life insurance policy, your beneficiaries won’t receive a payout when you die.
You’ll have to pay taxes on your cash surrender value. Thankfully, only the interest earned on the amount you paid is subject to taxes.
5. Life insurance settlements
You may be able to sell your policy to a third-party for a one-time upfront payment. The payment to you is usually less than the death benefit but greater than the cash value. Keep in mind that most provinces in Canada don’t currently allow life insurance policies to be sold – with the exception of Quebec, New Brunswick, Nova Scotia, and Saskatchewan. Some companies may also not allow their policies to be sold even if it is permitted by the province, so check with your insurance company first to learn its stance on selling life policies.
When you might want to cash out your policy
Permanent life insurance policies provide a lifetime of financial protection for you and your family. However, there are many reasons to cash out your life insurance policy. From financial hardships to changes in lifestyle, here’s some situations when you might consider using some or all of the cash value of your policy.
You found an insurance provider with better options
There are many insurance providers that are eager to accept your premium payments. Whether you found another provider with better coverage or a policy that is more suitable for your lifestyle, sometimes there are better options out there. If you’re wondering what options you may have, check out some life insurance providers below.
You no longer need coverage
If your beneficiaries have passed away or don’t rely on your financial support, you may not need coverage. Selling or surrendering your policy provides an influx of cash to help you in the later years of life.
You have large financial commitments
Whether you’re buying a new home, funding a child’s education or simply need cash quick, loans, surrenders and settlements can provide funds — fast.
You’re in debt
If you owe money, borrowing from your life insurance policy is an option to get you out of debt. Interest rates are much lower than credit cards and other types of loans, so this option may help you save money while reducing debt.
You want to reduce your premiums
If you don’t need as much coverage or find that your premium payments are too high, you may consider cashing out of your policy. That could mean using some of your cash value to cover premiums, taking out a loan or surrendering the policy.
You have poor credit and need cash fast
If you’re in need of cash but have poor credit, cashing out of a life insurance policy may be a good option. Policy loans do not require credit checks, and neither do settlements or policy surrenders.
Alternative to cashing out a policy: Personal loans
If you’re in a pinch for cash but don’t want to sacrifice your life insurance policy, you may want to consider applying for a personal loan. Available from banks, credit unions and personal lenders, personal loans can provide quick access to funds at reasonable interest rates. As with any major financial decision, you should always consult an accountant or financial advisor to determine what’s best for your situation.
There are a handful of reasons why you might consider cashing out your life insurance policy. Whether you’re in debt, making a large purchase or just don’t need coverage anymore, cashing out your policy can provide financial cushioning when you need it most. Each method offers its own benefits and drawbacks, so it’s important to weigh your options carefully. Before making a decision, you should always consult a licensed accountant or financial advisor for tailored advice.
If you want to learn more about life insurance and what options are available, check out our comprehensive guide here.
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