Cash Out of Your Life Insurance Policy

Mar.15.2021

At some point in your life, you probably purchased a life insurance policy. You wanted to make sure that your family was taken care of and financially secure in the event something was to happen to you. Other than paying the premiums each year or each month, you might not have thought much about that policy since you bought it.

But what if you’ve stumbled upon some financial hardship? There is no way to know if or when something may happen in your life that leaves you worried about how you are going to pay bills, cover medical expenses, or even keep your home. This can be an overwhelming and scary feeling.

If you have life insurance policy with a cash value, you might be able to get the money you need to help you get back on track now.

How to get cash from a life insurance policy:

There are several different ways you can get cash from your life insurance policy. They will vary depending on your specific policy, but they include:

  • Taking out a loan against the cash value of your policy
  • Surrendering your policy for its cash value
  • Life settlement (one way to sell a life insurance policy)
  • Viatical settlement (another option to sell a life insurance policy)
  • Utilizing cash value withdrawals 

Depending on the type of life insurance policy you purchased, it may accumulate cash value over time from the premiums you’ve paid into it. This cash is available for you to access in the event of unexpected expenses. 

Each option has pros and cons and will have different requirements and implications, so you’ll want to be familiar with all your options prior to making a decision.

Option one- cash value withdrawal:

This is a straight-forward option that works exactly how it sounds. You withdraw funds from the cash value your life insurance policy has accumulated over time. The funds are typically tax free. They type of policy you own and which insurance carrier you use can both affect the amount of money you will be allowed to withdraw. You will need to contact your insurance agent to discuss your specific situation and file a claim. Once that has been done the agent can issue you a check.

Some disadvantages to withdrawing the cash value of your policy include:

  • Your policy premiums may increase. This would make your policy more expensive each month, and if you’re already in a tough financial situation, this could mean you may no longer be able to afford the premiums. If you are unable to pay them, your policy will lapse and you will lose coverage.
  • Your death benefits may decrease. If your death benefit were to decrease, your beneficiaries would receive less money in the event of your death. This could make it hard for them to remain financially secure if something was to happen to you.

Your insurance agent will be able to provide you with detailed information regarding the implications to either your premiums or your death benefits, or both. This is something you will want to fully understand prior to withdrawing any cash value from your life insurance policy.

Another thing that is important to consider is whether your life insurance policy might be a Modified Endowment Contract (MEC). There is a process called the Seven Pay Test that call help you determine if your policy is classified as a MEC. The Seven Pay Test limits the amount of premiums that can paid towards your policy over a period of seven years. If during that seven-year period the premiums exceed that amount, the policy automatically becomes a MEC.

The goal of the Seven Pay Test is to make sure that a life insurance policy remains valid. It accomplishes this by assuring that a certain dollar amount remains between the cash value of your policy and the death benefits value at all times.

If your policy has been classified as a MEC, it doesn’t mean you can’t access the cash value. It does, however, mean that the money will be taxed. If you are less than 59 ½ years old, you will pay a ten percent tax on any funds withdrawn from a Modified Endowment Contract. 

While withdrawals from the accumulated cash value of your policy are typically tax free, if the cash value exceeds the amount of all your premium payments, any amount that you withdraw that exceeds the amount of premiums you paid in will be considered taxable income and you will need to report it.

You will want to speak with your insurance agent to determine if your policy is considered a Modified Endowment Contract and what your best options are in that case.

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Option two- a loan with cash value as collateral:

You can take out a loan from the accrued cash value of your policy by using the cash value as collateral. This loan does not have to be repaid; however, the insurance company will charge interest on the loan and it will need to be paid in cash or with any remaining cash value in your insurance policy. 

This can be a good option for someone with poor or no credit history since there are no financial underwriting requirements involved. As stated before, you do not need to repay this loan, however, you should be aware that the policy will have a lower cash value going forward. This option also has limitations that are determined by the policy type and the insurance carrier, so you will need to speak with your insurance agent to determine if this is an option for you.

A couple of things you want to be aware of if you’re considering a cash value collateral loan include:

  • The interest charged by the insurance carrier will need to be repaid, and if you have taken out a large loan and the interest isn’t paid as agreed, your policy could lapse. 
  • If there is an outstanding balance from a loan at the time of your death, the amount will be deducted from the death benefits. This will in turn leave less money available to your beneficiaries.
  • If the policy does lapse, any funds from the loan that you have not repaid can be subject to taxation.

If your policy is determined to be a Modified Endowment Contract and you utilize the collateral loan option, the same taxation policies described above will apply.

Option three- surrendering your life insurance policy:

If you decide you want to cancel the policy altogether, you will notify your agent that you wish to surrender your policy. You will then be given a check in the amount of the cash value your policy has accumulated while it was in force.

Some things to keep in mind if you choose to surrender your policy include:

  • As it sounds, surrendering your policy effectively terminates it. This means your beneficiaries will not receive any death benefits upon your death because the policy will no longer be in force.
  • Any money in excess of what you have you paid into your policy will be counted as taxable income and will need to be reported.
  • If there any loans left unpaid on the policy, they can also be subject to taxation.
  • Many carriers have policies in place that charge you a fee if you surrender a policy within just a few years of purchasing it. If this is the case, the amount of money you may get from surrendering your policy will be less.
  • If you decide that you want to purchase a new life insurance policy in the future, your rates will be higher due to your attained age and any changes in your overall health.

Since this method will terminate your policy and your beneficiaries will no long receive any death benefits upon your passing, you will want to make sure this is the best option for you and your current situation.

Option four- selling your policy in a traditional life settlement or a viatical settlement:

In this option you will sell your life insurance for a cash payout. A buyer will purchase your policy and you will receive a lump sum of cash or payments over a specified period of time. The buyer assumes all responsibility for premium payments on your policy and will receive the death benefits upon your passing.

Generally, to sell your life insurance policy in one of these scenarios you will need to be aged sixty-five years or older and your policy will need to have a face value (death benefits) of $100,000 or more. As your policy is an investment to its buyer, your life expectancy will also be a factor and usually they will want it to be no more than around fifteen years.

A viatical settlement has the added requirement that you be terminally ill. If you have received a terminal diagnosis and have a life expectancy of up to two, or sometimes four years, you may be eligible to sell your policy in a viatical settlement. 

One of the biggest appeals to selling your policy is that you will almost always receive a higher cash payout from this option that you would surrendering your policy for its cash value. In general, you can receive three to four times the amount of the cash surrender value. You will not receive the full amount of the death benefits, however.

One of the big differences between a viatical settlement and a traditional life settlement is the tax implications. Viatical settlements are not usually subject to taxation, but traditional life settlements may be. You will want to talk to a tax advisor to make sure you understand the possible tax consequences of this option.

Some things to keep in mind with this option include:

  • Your beneficiaries will not be entitled to any death benefits upon your passing. They belong to the new policyowner.
  • There are fees associated with option, particularly if you use a life settlement broker to arrange the sale. The commission will be deducted from your payout.

You will want to speak with your life insurance agent if you’re considering selling your policy to make sure you fully understand the process and know how to proceed.

Wrapping it up:

It is definitely possible to get cash out of your life insurance policy while you are still living. Each option has its unique set of pros and cons. You will want to research them all and decide which one is best for you. Once you have decided, your insurance agent can help guide you through the necessary steps. While you always want to fully consider the implications of cancelling any form of insurance coverage, sometimes it might your best option. With the help of your agent, you can be on your way to acquiring the cash you need.

Frequently asked questions:

Can I get cash from my life insurance policy without selling or surrendering it?

Yes. You can withdraw from its cash value or take out a loan against the policy. You want to make sure you understand how these options will affect your policy, so speak with your insurance agent.

Do I have to be terminally ill to sell my policy?

No. You do need a terminal diagnosis to sell your policy in a viatical settlement, but not for a traditional life settlement.

Will the money I receive from a policy sale be taxed?

Sometimes. A viatical settlement is generally not taxed, but a life settlement might be. A tax advisor can explain the implications to you so you know what to expect.

Where does the cash value in my policy come from?

Your life insurance policy builds up a cash value over time as you pay premiums into it. This acts as a sort of savings account that you can withdraw from or borrow against if needed in the future.

What if I don’t have good credit? Could I still take out a policy loan?

Yes, you can. Taking out a loan against your policy doesn’t involve financial underwriting, so you can still borrow the money without a good credit history. Not paying it back could cause your policy to lapse, however.

How do these options affect the death benefits on my policy?

Selling or surrendering a policy either one will mean you have forfeited the death benefits. Your beneficiaries will not receive anything upon your death. If you withdraw cash or borrow against the cash value, your death benefits may decrease.

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