Unexpected expenses, such as medical bills, major home repairs, or living expenses if you lose your job, may occur regardless of how well you plan. If you have a large payment coming up and not enough money in your emergency fund, you may be wondering:
Can you cash out a life insurance policy?
The answer depends on the type of life insurance you have and its age. Some life insurance policies, in addition to giving a death benefit, accumulate cash value, which you can receive at any time during your lifetime.
You can access the accrued cash value in a variety of methods, including cash value withdrawals, policy loans, and surrendering the policy. Keep in mind that if you withdraw money from your insurance, your dependents may receive less or nothing at all when you die.
What types of life insurance policies build cash value?
There are two types of life insurance policies: term and permanent. Term life insurance policies, as the name suggests, provide coverage for a specific time period. These plans have one goal in mind: to provide cash benefits to your beneficiaries in the event of your death.
As long as you pay your premiums, permanent life insurance will cover you for the rest of your life. Whole life insurance and universal life insurance are two types of permanent policies.
Cash value builds up in all whole life insurance policies and in most universal life insurance policies. When you pay your premium, a portion of it goes toward the cost of coverage and administrative fees, while the rest goes into a built-in savings or investing account. Money in this account grows tax-deferred, which means it is not taxed until it is withdrawn. This is referred to as cash value.
The cash surrender value of your policy is available to you for use during your lifetime. You can use the money for anything, from boosting your retirement income to paying unforeseen medical expenditures or assisting your child with university fees.
How to use the cash value of your insurance policy?
Whole life and universal life insurance accrue cash value differently, but both offer five options for accessing it:
1.Taking out a policy loan
Taking out a policy loan is essentially borrowing against the cash value of the policy. There are no eligibility conditions, although most insurers will not let you borrow until your cash value is of a particular value. You can borrow a portion or all of the minimal cash value once you have it.
Interest rates for policy loans are lower, and repayment terms are flexible. Furthermore, because you are borrowing your own money, repayment is not required. But, if your family still requires life insurance cover, you would be better off repaying the entire borrowed amount as quickly as possible. Otherwise, if you died, your family would receive a reduced or no death benefit.
Assume you have $100,000 in permanent life insurance. Due of a financial exigency, you borrowed $20,000 against the cash value. Regrettably, you died two years later without repaying any of the money. Because the entire loan value was $23,000 at the time of your death, your family would get just $77,000 (less than the initial $100,000 death benefit).
The longer you wait to repay the debt, the more interest will accrue. When the entire value of the loan exceeds the cash value of the policy, your coverage will be terminated. If you die after the policy has expired, your family will receive no compensation from the insurer.
2.Making a cash value withdrawal
You can withdraw the cash value in part or in full for any reason. Yet, there is a catch: if you do, your family will receive less benefit when you pass away. A cash value withdrawal can diminish or fully eliminate the death benefit, depending on how much money you withdraw and the terms of your policy.
With universal life insurance policies, each withdrawal diminishes the coverage amount dollar for dollar. However, in the case of some whole life plans, the death benefit is decreased by an amount greater than the amount withdrawn. Before you file for a withdrawal, be sure you understand how it will affect the face value of the policy.
3.Using the cash value as loan collateral
This involves getting a loan from a third party and using the cash worth of your policy as collateral. If you die without repaying the entire loan, the insurer will use your death benefit to pay off the remaining sum to the lender. The leftover cash will go to your beneficiaries.
If another financial institution offers you a better rate, you could use the cash value as loan collateral. However, establishing such a loan is usually more difficult than making a cash value withdrawal or taking out a loan against your policy.
A life settlement is the sale of an active policy to an individual or a company in exchange for money. In most cases, the money received in return surpasses the cash value of the policy.
While a life settlement may be a viable alternative if you are in a bind and no longer require coverage, keep in mind that it is only permitted in four Canadian provinces: New Brunswick, Saskatchewan, Nova Scotia, and Quebec.
However, even if you live in one of these provinces, before seeking for a buyer, verify with your insurer about their policy on selling life insurance plans. Some insurers do not allow life settlements at all, therefore even if you live in a province that allows life settlements, you will be unable to sell your insurance.
5.Surrendering your policy
By surrendering your full life insurance policy, you can cash it out. Surrendering a policy in the context of permanent life insurance involves cancelling or terminating coverage. When you surrender your policy, the insurer will give you the net cash value, which is the entire cash value less the surrender fees.
Surrender fees vary depending on the insurer and the age of the policy. The longer you keep on to your insurance, the lesser the surrender charges will be.
Can you cash out life insurance?
Like most individuals, you probably purchased life insurance to protect your family's future. But, if you no longer have dependents or do not wish to wait until death to collect life insurance proceeds, you may be wondering if you may pay out life insurance before death.
Yes, if you have a permanent life insurance policy with a cash value. By surrendering the insurance, you can cash out the entire amount.
For the first several years, the cash value develops slowly, and the surrender charges are rather high. As a result, relinquishing the policy only makes sense if you've owned it for a while, say 10 or 15 years. Instead, all or a significant portion of the cash worth would be used to pay off the surrender fees.
Keep in mind that if you die without a current insurance, your family will receive no financial benefit. If you still require life insurance, examine other choices such as a policy loan or cash value withdrawal.
Do you have to pay taxes when cashing out a life insurance policy?
The amount of tax you will pay when you cash out your insurance is determined by the cash surrender value. Taxable income is the portion of the surrender value that exceeds the cost base.
The amount of all premium payments is the cost basis. If the cash surrender value is larger than the amount paid in premiums, the remaining money reflects investment or interest gains and consequently is taxable
Is there a penalty for cashing out life insurance?
You will almost certainly have to pay surrender charges if you relinquish a whole life or universal life insurance policy. If you pay out the policy in year one, the surrender cost is usually 10%, but it can sometimes be as high as 30%. The surrender cost is normally less than 1% of your cash value after 10 or 15 years. In fact, it is fairly uncommon for life insurers to waive this fee entirely for plans that are 10 or 15 years old.
What if I do no’t use my cash value?
The cash value in your life insurance policy is for you to use while you are still alive. Any unused cash value at the time of death reverts to the insurer.
When is a good time to cash out my life insurance?
Life insurance is primarily purchased to guarantee the well-being of your loved ones after your death. But, there are situations when withdrawing funds from your permanent life insurance policy may be a sensible idea.
You may consider cashing out your policy if:
You no longer require life insurance protection - If you have no dependents or your beneficiary has passed away, you can securely surrender the policy for its cash value.
You require less protection - Assume you purchased the policy when your children were small and you had a mortgage to pay. You just need a small policy to cover end-of-life expenses now that the children are financially independent and the mortgage has been paid off in full. In this case, cashing out your existing plan and utilizing a portion of the proceeds to acquire a last expense coverage makes perfect sense.
You can no longer pay the premiums - Cash value life insurance policies are not inexpensive. These are often 10-15 times more expensive than term life insurance. If your financial status changes and you are unable to pay the premiums, cashing out your current policy and purchasing a term life plan may help ensure your family does not lose the financial security they require.
You no longer require life insurance coverage- You can safely withdraw if you no longer have dependents or if your beneficiary has passed away.
You have a huge financial commitment - Whether you want to pay a child's college education, purchase a new home, or need cash quickly, cashing out the policy, partially or totally, can provide you with the income you require – quickly.
You require cash but have a terrible credit history - A low credit score can make acquiring a personal loan prohibitively expensive. In this case, cashing out your life insurance policy could be a wise move. When you ask for a policy loan, cash value withdrawal, or policy surrender, the insurer does do a credit check. A credit check is also not required for a life settlement.
Alternative Ways to Get Money Fast
The death benefit of your life insurance policy is reduced when you withdraw money from it. Consider taking out a personal loan if you prefer to keep the policy amount intact. Credit card loans offer higher interest rates than personal loans. A bank, an internet lender, or a credit union can all help you get one.
A home equity loan is another way to get money out of your insurance. It enables you to borrow against the value of your house. Normally, you can borrow up to 80% of your equity.
Access the cash value
If you're short on cash, you might wonder: Can you cash out a life insurance policy before death? Cashing out money from a policy is only a possibility if the policy has financial value. A cash value component is included in all whole life plans and most universal life policies, although term life policies do not.
You can access the cash value in a variety of ways, including taking out a policy loan, withdrawing money from the cash value, or surrendering the policy. When taking money out of the insurance, think about how it would effect the death benefit. A personal loan or home equity loan is a preferable option if you do not want to risk diminishing the death benefit.
Looking to learn more? Reach out to a Dundas Life advisor today and we can help you find the right life insurance plan for your needs.