Can life insurance be cashed out?

If you’re one of the 52% of Americans who carries some form of life insurance, cashing out your life insurance policy might seem like a viable option for making ends meet during difficult economic times.

Despite the financial benefits that can come from cashing in your life insurance, there can also be significant drawbacks that every policyholder should be aware of. From unanticipated penalties and taxes to negatively impacting your family’s financial future, cashing in an insurance policy while you’re still alive can have consequences for you and those around you.

Can you cash in your life insurance policy? We’re here to help answer that question. This article will cover what policyholders need to know about cashing in a life insurance policy before death, including understanding your policy’s cash value, the common methods for how to cash in your life insurance, the advantages and risks associated with cashing out your policy, and alternatives that might be better suited to your future goals.

What does it mean to cash out life insurance?

When someone “cashes out” their life insurance, it means they’re surrendering their life insurance policy in exchange for cash while they’re still alive. It’s important to keep in mind that there are limits on how much cash you can receive from cashing in a life insurance policy. Although every policy is different, the cash value of life insurance is usually lower than the full amount of the death benefit that your insurer will pay to your beneficiaries after you’re gone. There is also a difference between cash value and surrender value.

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Determining Whether Your Policy Has Cash Value

For those wondering how to cash out life insurance, it’s a good idea to start by confirming that your policy has cash value (the amount of money an insurer will pay you if you cash in your policy while alive). 

Life insurance policies that accumulate cash value are usually limited to “whole life” or permanent life insurance. Most types of term life insurance don’t accumulate cash value and, therefore can’t be cashed out. However, it’s best to check your policy or contact your insurer directly to determine whether your policy carries a cash value.

Read more:

• Can I cash out a term life insurance policy?
• Reasons Why Life Insurance Won’t Pay Out

Cash Value vs. Death Benefits

When deciding whether to cash in your life insurance policy, it’s important to remember that your policy’s cash value is different from its death benefit (the amount that an insurer will pay to beneficiaries after the policyholder’s death). For example, if you have a life insurance policy with a death benefit of $250,000, your policy’s cash value might be significantly less than its death benefit. 

Benefits of Cashing Out a Life Insurance Policy

The primary advantage of cashing out a life insurance policy is receiving a cash payout based on the policy’s cash value. This can be especially beneficial for those in desperate financial situations with no other options for acquiring cash to cover basic living expenses and necessities.

Disadvantages of Cashing Out a Life Insurance Policy

Although cashing out a life insurance policy can be advantageous for those in dire need of cash, it can also come with significant drawbacks that should be considered carefully before making any decisions.

Impact on Beneficiaries’ Financial Future

Life insurance policies cover the costs of certain expenses after your death. For example, depending on your policy, your life insurance may cover the cost of your funeral expenses and burial. In some cases, your policy might also provide additional financial benefits for family members such as spouses, partners, children, and dependents after your death. Additionally, some policies provide disability income for the policyholder if they cannot work due to an illness or injury.

Because of the potential consequences of forgoing life insurance coverage, it’s important to consider the impact cashing in your life insurance policy could have on your family’s financial future.

Penalties and Fees

Not all life insurance policies impose penalties or surrender fees. However, some do. Check your policy contract or contact your insurer to find out if any fees or penalties are associated with cashing in your policy.

Taxes

If your life insurance policy is classified as a Modified Endowment Contract (MEC), you could be subject to federal income taxes or early withdrawal penalties depending on your age at the time of cashing in your policy. Cashing out your life insurance early may affect whether your life insurance is taxable.

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How to Cash In a Life Insurance Policy Before Death

If you’ve weighed the benefits and risks of cashing out a life insurance policy and decided that it’s the right choice for your situation, there are several ways to cash out your life insurance while alive: 

• Surrender your life insurance policy. By canceling and surrendering your policy to the insurance company, you can receive the cash value of the policy less any fees.
• Withdraw the partial cash value of your life insurance policy. Depending on your policy, you may be able to withdraw part of the cash value of your life insurance without canceling your coverage. Also referred to as a partial cash surrender, policyholders typically won’t be subject to income tax or other penalties on withdrawals up to the value of a policy’s premium, although these rules can vary.
• Apply your policy’s cash value to its premium. If you’re having difficulty affording the premiums on your life insurance policy, you may be able to apply your policy’s cash value toward your premium to retain coverage.
• Borrow cash against the value of your policy. Some policies allow you to borrow cash against the cash value of your life insurance. However, when you take out a life insurance loan, be aware that you will likely be expected to repay it with interest. This obligation can be passed on to your beneficiaries if the loan hasn’t been repaid before your death.

Read more: How to Cancel a Whole Life Insurance Policy

Understanding Living Benefits

Some permanent life insurance policies offer living benefits, which allow policyholders to cash out their policy before death under specific circumstances. Often, this includes a terminal or chronic illness or the need for long-term care. 

For policyholders who qualify for Medicaid, it’s important to speak with a Medicaid representative to understand the living benefits available to you and how they could affect your life insurance benefits before cashing out your policy.

Alternatives to Cashing Out Your Life Insurance

Because some life insurance policyholders might view cashing in their policy as too risky, there are alternatives for accessing money when cash is tight. Other options include borrowing from your 401(k) or taking out a home equity loan that can be repaid over a longer period of time. Although both options have advantages and disadvantages, they allow you to retain life insurance coverage to protect your loved ones financially after your death.

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Case Studies: Can life Insurance be Cashed out?

Case Study 1: John’s Financial Crisis

John, a 45-year-old individual, found himself in a severe financial crisis due to unexpected medical expenses. He owned a whole life insurance policy with a cash value of $50,000. In desperate need of immediate cash to cover his medical bills, John decided to cash out his life insurance policy.

While this provided him with the necessary funds to address his immediate needs, it had significant implications for his family’s financial future. Without the life insurance coverage, his beneficiaries would no longer receive the death benefit, leaving them financially vulnerable in case of his untimely demise.

Case Study 2: Emma’s Retirement Dilemma

Emma, a 60-year-old retiree, had been diligently saving for her retirement over the years. She had a term life insurance policy with no cash value. However, due to unforeseen circumstances, she faced a significant financial setback and considered cashing out her life insurance policy.

After careful evaluation, Emma realized that cashing out her policy would leave her without any life insurance coverage, which could be detrimental to her future financial security. Instead, she explored alternative options such as borrowing from her retirement savings or downsizing her living arrangements.

Case Study 3: Sarah’s Living Benefits Option

Sarah, a 55-year-old policyholder, had a permanent life insurance policy that offered living benefits. She was diagnosed with a chronic illness that required extensive medical treatment and long-term care.

Sarah decided to exercise the living benefits option in her policy, which allowed her to access a portion of the policy’s cash value to cover her medical expenses. By utilizing this feature, Sarah could maintain her life insurance coverage while addressing her immediate healthcare needs.

Is cashing in a life insurance policy worth it?

Deciding whether to cash in your life insurance policy depends on your circumstances and future goals. Cashing out a life insurance policy can be worth it for those in dire financial situations where money is needed to cover basic living expenses, and no other alternatives exist. However, it’s important to remember that there can also be significant disadvantages to cashing in a life insurance policy.

If your family or beneficiaries will rely on your life insurance benefits to survive after your death, or if you have access to alternative sources of income, cashing in your life insurance policy might not be worth it. Depending on your policy, there might also be penalties, fees, and taxes to consider. Before cashing in a life insurance policy, carefully weigh the benefits and risks.

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