Can You Really Make Money by Cashing Out Life Insurance? Here’s How

Life insurance is more than just a safety net for your loved ones in the event of your passing; it’s also a versatile financial tool. While its primary purpose is to provide a death benefit to your beneficiaries, certain types of life insurance policies, like whole life or universal life, come with a cash value component. This cash value grows over time and can serve as a financial resource while you’re still alive.

One intriguing aspect of these policies is the ability to “cash out,” allowing you to access the accumulated funds. Whether through surrendering the policy, taking a loan, or selling it in a life settlement, cashing out can provide immediate financial relief or capital for other investments.

However, the process is not without its complexities. It involves understanding the value of your policy, potential fees, tax implications, and the long-term consequences of relinquishing coverage. By learning the ins and outs of cashing out a life insurance policy, you can make an informed decision that aligns with your financial goals and needs.

What Does Cashing Out Life Insurance Mean?

Cashing out a life insurance policy means accessing the cash value built up in certain types of life insurance policies while you are still alive. This cash value is a savings component that grows over time, separate from the death benefit. Cashing out can be done in various ways, such as surrendering the policy, borrowing against it, or selling it to a third party.

Types of Life Insurance Policies with Cash Value

• Whole Life Insurance: Includes a guaranteed cash value that grows at a fixed rate over time.
• Universal Life Insurance: Offers flexible premiums and an interest-earning cash value that grows based on market conditions.

Term Life vs. Permanent Life Insurance

• Term Life Insurance: Provides coverage for a set period but does not accumulate cash value.
• Permanent Life Insurance: Combines a death benefit with a cash value component, making it eligible for cashing out.

Ways to Cash Out Life Insurance

1. Surrendering the Policy

• Explanation: Surrendering involves canceling the policy and receiving its cash surrender value, which is the amount left after subtracting fees and any outstanding loans.
• How Surrender Value Is Calculated: The surrender value equals the total cash value minus surrender charges and any unpaid premiums or policy loans.
• Potential Fees and Penalties: Surrendering often comes with charges, especially during the early years of the policy. Additionally, any gain may be subject to taxes.

2. Taking a Loan Against the Policy

• How Policy Loans Work: You can borrow money against the cash value of your policy, using the policy itself as collateral.
• Interest Rates and Repayment Terms: While interest rates are usually lower than traditional loans, unpaid interest can reduce your death benefit.
• Risks of Defaulting: If the loan isn’t repaid and the policy lapses, the outstanding balance may be taxable, and beneficiaries may receive a reduced payout.

3. Selling the Policy (Life Settlement)

• What Is a Life Settlement?: A life settlement involves selling your policy to a third party for a lump sum, typically higher than the cash surrender value but less than the death benefit.
• Factors That Determine Value: Age, health, policy size, and premiums all influence the offer you receive.
• Pros and Cons:
  • Pros: Potential to receive more than the surrender value, relief from paying premiums.
  • Cons: Loss of death benefit for beneficiaries, tax implications on the proceeds.

4. Partial Withdrawals

• How Partial Withdrawals Work: Allows you to withdraw a portion of the cash value without canceling the policy.
• Tax Implications and Impact: Withdrawals up to the amount of premiums paid are typically tax-free, but anything above that may be taxed. They also reduce the policy’s death benefit.

Factors to Consider Before Cashing Out

• Financial Needs and Goals: Assess whether cashing out aligns with your immediate or long-term financial objectives.
• Impact on Beneficiaries: Cashing out reduces or eliminates the death benefit your beneficiaries would receive.
• Tax Implications: Understand the potential tax liabilities associated with gains or loans.
• Alternatives to Cashing Out: Consider borrowing from other sources or reducing premiums if the policy becomes burdensome.