When to Cash in a Life Insurance Policy
April 4, 2018 by Abby Hayes
Whether to cash in a life insurance policy is an important decision. The choice can have a number of financial implications, including tax liability. Here are some factors to consider before cashing in a policy.
If you’ve been reading on Dough Roller much, you may be aware that we tend to advocate for term life insurance policies rather than whole life insurance policies. Sure, whole life policies are a good fit for some individuals in certain situations. But for most of us, term is by far the cheapest way to go.
So what do you do if you found this out too late? Maybe you’re paying through the nose each month for a whole life insurance policy. Perhaps you’ve decided you want to switch to a term policy. But you have this cash benefit built up in your whole life policy.
What happens to it if you stop paying premiums? And should you just cash out that benefit? Or should you decide to cash out the benefit in an emergency? These are the questions we’re here to answer.
Cashing in your whole Life Insurance Policy
Before we talk about cashing in your whole life insurance policy, let’s make sure we’re on the same page about the policy’s cash value.
Most whole life policies come with two different portions. One is the death benefit. This is a set amount that you get upon death, or, in some cases, you can get in case of a terminal diagnosis.
The second portion of this policy is the cash value. This is what makes universal life insurance policies so much more expensive than term policies. You’re paying extra in premiums each month. Then the insurance company invests the additional premium, and you get some of the returns.
The cash value of your policy builds over time. If you’ve only been paying premiums for a few years, it probably won’t amount to much money. But if you’ve been paying on the policy for a couple of decades, you could have a hefty cash value available.
Borrowing vs. Surrendering vs. Withdrawing
You’ve got three available options for cashing in on most whole life insurance policies: borrowing against the cash value, surrendering your policy for the cash value, or withdrawing a portion of your premiums.
If you borrow from the policy, you may not actually need to pay back the money. But not doing so will reduce your death benefit. You can also cancel the policy to get out its cash value, or you can withdraw a certain amount of cash.
Borrowing on the Policy
In an emergency, borrowing from your whole life insurance policy’s cash value may be a reasonable choice. With most policies, you have to wait until you have a certain value available before you borrow. And you can probably only borrow a certain percentage of the available cash value.
But there are a couple of potential benefits to this strategy. One is that you may not have to pay back the loan. With many policies, the insurance company will simply reduce the policy’s death benefit by the outstanding balance of the loan.
However, it is often best to repay the loan if you intend to keep the policy. That’s because you’ll be charged interest on the loan, which can also eat into the death benefit. Over time, there may be no death benefit left for your beneficiaries, even if you continue paying premiums.
Basically, you should look at borrowing from your life insurance policy’s cash benefit as a last resort. If you really need access to cash and can’t get another loan or can only get one with a high interest rate, it can be a decent option.
One other situation is if you can’t afford your annual premiums but also don’t qualify for a term life insurance policy. Sometimes you can no longer get a term policy due to health concerns. If this is the case, you might borrow from your cash benefit to pay to cover the premiums. Your family will get a smaller death benefit if something happens to you. But something may be better than nothing.
Again, though, check the fine print on your policy before you take any of these options. Some policies let you use your cash benefit to pay for premiums without having to take a loan. And others may have additional terms surrounding loans from your cash benefit.
Surrendering the Policy
What if you just want to stop paying your policy’s premiums? This might be the case if you find out you qualify for much cheaper term life insurance. Or maybe you are at the point where you no longer need life insurance coverage at all. In this case, surrendering your policy may be the best option.
With a term insurance policy, you can just stop paying the premiums to effectively cancel your coverage. Not so with a whole life insurance policy. You have to actually call your insurance company to cancel the policy.
If your policy has been in place long enough to accumulate some cash value, you can then get this back out of the policy. Of course, this doesn’t come without fees. You’ll need to check with your insurer on what fees you’ll pay.
And remember, if you stop paying premiums and cancel the policy, you’ll be without a death benefit. This would leave your family vulnerable if the worst were to happen. So your best bet is to either be in a place where you no longer need insurance or to switch from a whole life to a term life insurance policy.
Withdrawing from the Life Insurance Policy
With many whole life insurance policies, you can get back out a certain amount of money that you put into the policy. Remember, these policies are sort of like investment vehicles. And as with other investments, you can often get back out the amount you’ve paid in without paying additional taxes. However, if you dip into any of the account’s gains, you’ll pay taxes on the amount.
Policy withdrawals have different effects, depending on your policy. They could reduce your death benefit like a loan would. Again, be sure to check with your particular policy before making this type of decision.
Potential Fees and Other Gotchas
One thing to note when taking any of these steps is that the insurance company may impose fees, as noted in your contract. These can be quite hefty and may eat into the available cash you can get out of your policy. And if you withdraw money that was earned on top of your investments, you’ll most likely have to pay income taxes on that money, too.
Your best bet before making these decisions is to talk with a financial advisor who can give you the pros and cons of each option. But, ultimately, sometimes it’s best to just get rid of your policy and move into a term life insurance policy or no life insurance at all.
So When Should You Take the Cash Value?
If you’re planning to maintain your life insurance policy, your best bet is to refrain from borrowing or withdrawing from the policy unless absolutely necessary. These moves can put you in a financial bind or wear down the amount of death benefit available for your family should they need it. These moves are available if you need them, but try other avenues first.
But what if you no longer want or need to maintain the policy? Depending on your age and health, you can most likely get a term life insurance policy with the same death benefit for a much lower premium. You could cancel your whole life insurance policy, buy term coverage, and invest the difference in premiums–likely for better returns.
If you bought a whole life insurance policy you didn’t really need, don’t keep paying into it because you assume that’s the only option. Instead, price out term policies. If they turn out to give you more bang for your buck, it may be time to surrender that whole life policy. You can always invest the money from the cash value, getting better returns over time.
And what if you’re in a situation where you no longer need life insurance? If you have very little debt and no dependents, you may not need to maintain a policy at all. In this case, you shouldn’t keep paying for a whole life insurance policy unless it’s part of a well-considered estate plan. If you don’t need the policy anymore, call your insurance company to cancel it. Again, you can take the cash benefit your pocket and invest it for the future.
Whole life insurance policies are the best option for some people, especially those who will always have dependents due to disabilities and the like. But if you’re paying for an expensive policy you don’t really need, cashing out may be the best option, even if you have to pay fees and taxes. Just be sure you know exactly what those expenses will be before you initiate the process.
Finally, whole life and universal life policies can be extremely complicated. Any decision you make may have tax implications. The key is to seek the advice of a qualified life insurance specialist before making a decision.
