How to cash out your life insurance policy

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.

How to use your policy’s cash value

Borrowing from the cash value

A great feature of permanent life insurance is the option to borrow from your policy’s cash value. 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 the perks of these policy loans. Since you’re essentially borrowing from yourself, there are no required monthly payments. However, even with low interest rates and a flexible payback schedule, 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.
• Taxes. If either of these situations occur, the outstanding loan balance plus any interest is subject to taxation.

Cash value withdrawals

If you don’t intend on paying back the loan, you can simply withdraw from your cash value. The amount you can withdraw depends on your policy and provider, but it’s likely less than a policy loan.

Withdrawals are untaxed up to the amount you’ve paid in premiums. This technique is best suited for those who need cash quick but don’t want to give up coverage or ownership. However, there are a few main drawbacks:

• Reduced death benefit amount. Withdrawals that reduce your cash value may cause a reduction in the death benefit amount, reducing the payout to beneficiaries when you die.
• Tax implications. Withdrawals are not always tax-free. If you happen to make a withdrawal within the first 15 years of the policy, reducing your policy’s death benefit, some or all of your withdrawal could be taxed.
• Increased premiums. Withdrawals that reduce the cash surrender value of your policy may reduce your benefit or increase your premiums to maintain the same death benefit amount. If the policyholder fails to pay the increased premiums, the policy could lapse, which could be subject to taxes.
• Modified endowment contracts. If your policy has been classified as a modified endowment contract (MEC), withdrawals may be subject to income tax and a 10% early-withdrawal penalty if you’re under the age of 59½ years old at the time of the withdrawal.

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.
• Taxes. The profit you make from surrendering your policy is subject to taxes. While the entire amount won’t be taxed, the gains will. In combination with surrender fees, this can quickly add up.
• 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 for your policy.
• Give up death benefit. Your beneficiaries won’t receive a death benefit if you surrender your life insurance policy.

Life insurance settlements

Another option is to sell your policy to a third party, who takes over your premium payments and the policy’s ownership. This is known as a “life settlement.”

You’ll likely receive less than the value of your death benefit, but more than you would from surrendering your policy. This is ideal for policies with higher cash values. The amount you’ll receive is up to you and the third party to decide, but here are some considerations before selling your policy:

• Reduction in your family’s financial security. Life insurance settlements generally require you to give up all ownership of your policy. If you die, your beneficiaries won’t receive any of the death benefit.
• Tough to find the right price. There isn’t a whole lot of regulation surrounding life insurance settlements, so it can be hard to determine a fair price for your policy.
• Expensive fees and taxes. Life insurance settlements are subject to commission fees as high as 30% of your proceeds. On top of that, life insurance settlements are subject to taxes, meaning you’ll get even less.
• Eligibility for social assistance programs. If you rely on social assistance programs, your life insurance settlement may affect your eligibility for things like Medicaid.

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 cashing out 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 better suits your lifestyle, sometimes there are better options out there.

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 or 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.

What to watch out for

Many personal lenders like payday loan companies often partake in predatory lending practices that can cause more harm than good. Look out for high interest rates and questionable terms to avoid expensive repayments that could trap you in a cycle of debt.

Compare your options and be sure to read the fine print of any loan to understand all of the fees and terms before going with a particular lender.

Bottom line

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 simply don’t need as much coverage, 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 or consider a personal loan. Before making a decision, you should always consult a licensed accountant or financial advisor for tailored advice.