Life insurance is a contract between a policyholder and insurance company that agrees to pay your dependents a death benefit when you die. The purpose of taking out a life insurance policy is to offer your loved ones a safety net in the event of your untimely passing.
However, life circumstances can leave you needing cash for surprise expenses. Cashing in your life insurance can be a source of funds in an emergency or during a financial downturn. Explore the reasons you may need to cash in your life insurance policy and how to go about obtaining the funds.
Reasons for Cashing in your Life Insurance Policy
Unforeseen money problems are the most common reason for cashing in life insurance. However, a change in health, high premiums, and retirement are additional reasons you may consider cashing in your life insurance policy.
A Change in health
Receiving a diagnosis of a chronic or terminal illness can throw your life into a tailspin. Weighing the benefits your policy will have for its beneficiaries against your ability to deal with your condition is a tough dilemma to face. Out-of-pocket medical expenses can build up, putting stress on your retirement savings. Cashing in your life insurance policy may cover the cost of surgeries, treatments, and other medical care.
Your premiums are too high
Some life insurance holders’ premiums increase over time, making policies unsustainable for the holder’s initial budget. On average, premiums rise 8% to 10% for every year of age. Doing away with costly premiums can increase cash flow for individuals who choose to cash in their policy.
Depleted cash surrender value
Certain types of permanent life insurance, such as universal life insurance, allow you to withdraw or borrow against their cash value. If you take out a significant portion of your policy’s cash value, you may be better off cashing out. Similarly, if you borrow the entire amount of your policy’s cash value, it may make sense to cancel the policy.
More money for retirement
The most recent CDC numbers place life expectancy in the U.S. at 77 years. Many people of retirement age face a long retirement with potentially limited funds. This situation makes cashing in a life insurance policy a viable option for financial support. Cashing in your life insurance policy can support your retirement portfolio and help you live comfortably.
How you can Access Cash from your Life Insurance Policy
A cash-value life insurance plan builds cash reserves via excess premiums and earnings. A cash-accumulation account within your policy holds these deposits until the need arises to withdraw funds. Accessing accumulated cash can occur through withdrawals, loans, canceling your policy, or through a life settlement.
When looking to access funds from your life insurance, you should be aware that owners of term life insurance cannot take advantage of a cash value benefit. They can, however, make withdrawals or pay premiums to use cash.
You can withdraw money from your policy if you find yourself in a financial bind. The amount you can withdraw differs depending on the type of life insurance policy you own. It also depends on any limits the issuing life insurance company places. Before making any withdrawals against your life insurance, learn about the potential consequences of accessing cash from your policy.
Withdrawals that reduce your cash value could cause the death benefit lower. A reduced death benefit is an element to consider if you plan to secure funds for your beneficiaries, especially if they intend to depend on the death benefit for their livelihood.
Though cash value withdrawals are generally tax-free, there are cases where a withdrawal is considered a taxable action. One example would be to make a withdrawal early on. If your withdrawal causes the policy’s death benefit to lower, a portion or all of the cash you take out could be taxable.
The IRS notes the tax implications for withdrawing from your life insurance policy. The IRS does not consider the cash you take out part of your ordinary income. This means that the funds are not taxable as income, and you do not have to report it as such. However, if you take out more than your base amount, you must report anything over this number as taxable income.
Besides making a withdrawal, you can borrow money using your accumulated cash as collateral. Borrowing accumulated cash causes your death benefit to lower but presents a viable option when you need money to invest in your financial future.
When taking out a loan against your policy’s cash value, you don’t have to repay the outstanding loan balance if you choose not to. This action may prove beneficial in the case of a financial emergency.
Repaying the loan is advised if you can afford to. Not paying the loan back will reduce the face amount when it comes time for a claim payout.
Canceling your policy
Canceling your policy is another way of getting funds from your life insurance. It will also reduce your expenditures as you will no longer have to make premium payments. If you cancel your policy too early in your ownership, the insurance company may charge fees. These fees may affect the final cash payout you receive.
A life settlement is when you sell your life insurance policy to someone else for its cash value. The purchaser can be an individual or a life settlement company. Life settlement companies are entities that buy life insurance policies for the lowest possible amounts to make a return.
Learn More about Life Insurance
Whether you cash in your life insurance policy or elect to use one of the other methods for securing funds from your policy, understanding the fine print is essential. Getting the most out of your life insurance coverage should start well before signing the contract.
Knowing how to examine life insurance offers and being clear on the terms that govern your policy will make it easier to cash it in if circumstances call for it. The experts at Finance is us help you recognize the critical times in life that you need life insurance the most. Whether you’re a new grad starting your professional career or a parent looking out for your child’s future, get to know the nuances of life insurance today.
Disclaimer: All content on this site is information of a general nature and does not address the circumstances of any particular entity or individual, nor is the information a substitute for professional financial advice and services.