Can you cash out your life insurance policy?

Feeling the added pressures of inflation and overall challenging economic conditions on their finances, many Americans may be looking for some added financial assistance. For some, that could mean tapping into their life insurance policies for cash.

Before you make the choice to cash out your life insurance, it's important to understand all of the details. Then, you can weigh both the advantages and disadvantages of this strategy to determine if getting cash out of your life insurance policy makes sense for you.

If you don't have life insurance, or want to increase the amount you currently have, start by getting a free price quote now.

Can you cash out your life insurance? 

Depending on the type of insurance you carry, you may have a few options to access cash from your life insurance.

Access a permanent life insurance policy

If you have a permanent life insurance policy, you may be able to dip into your policy's cash value account. Whole life, universal life and variable universal life are types of permanent life insurance policies that never expire and maintain cash value in addition to a death benefit.

By contrast, term life insurance is in effect for a limited term, such as 10, 20 or 30 years. The policy has a death benefit which pays beneficiaries if the policyholder passes away during the term. But one of the most significant differences between whole and term life insurance is that the latter policy does not have a cash value account, so there's no cash for policyholders to access.

Taking money from your cash value account could make sense if you're in a strong financial position and your beneficiaries will be taken care of after your death. On the other hand, if you have loved ones who rely on you financially, it's probably not wise to pull away the financial safety net your life insurance provides.

Get a free price estimate today to see what life insurance protections you're eligible for.

Surrender your life insurance policy

This option allows you to withdraw the entire cash value of your life insurance policy, which in turn surrenders your coverage. You'll receive all the money you've paid towards your coverage and any interest you've earned. Again, you should make sure you're in good financial standing and your beneficiaries are covered before you decide on this option.

Your insurer also considers any unpaid loans or premiums on your account and you could owe surrender fees and federal taxes.

Make a withdrawal from your policy

Another potential option is to withdraw money from your life insurance policy's cash value account. While these withdrawals are tax-free up to the amount you've already paid towards your premiums, any amount you withdraw that exceeds what you've already paid is taxable. 

Borrow from your policy

Your life insurance policy may allow you to take out a loan on the cash value. Getting a loan from your insurance policy may be easier than through a bank or credit union, because there is typically no credit check and more flexible repayment terms. But remember: Any amount you owe on the loan's outstanding principal and interest is deducted from the death benefit when you die.

Cover your policy's monthly payments

If you need cash to meet other expenses, you may have the option of drawing on your cash value account to cover the policy premium. This option can help you get through a tough financial spot without forfeiting your policy. Remember, if you end up depleting your cash value, your insurance could lapse, thus ending your coverage.

Pros and cons of cashing out your life insurance

Weigh the advantages and disadvantages of getting cash from your life insurance to help you decide if it makes sense for you. 

Pros of taking out cash from a life insurance policy

• It's simple: Policy loans generally don't require a loan application or credit check because the cash value in your account serves as collateral on the loan. You can repay your loan on your own schedule, and your payments go back into your policy. 
• Low interest rates: The interest rate you receive on a cash value loan can vary depending on whether your loan is fixed or variable. Typically, interest rates on life insurance loans range from 5% to 8%, which is far better than credit card interest rates and even slightly better than personal loan rates. Of course, you won't pay interest if you simply withdraw the money, but that lowers your cash value amount, which can take a long time to rebuild.
• No impact on credit: Taking out a mortgage or a personal loan could cause a temporary minor drop in your credit score. That's not the case with a life insurance loan, since your eligibility is primarily based on the amount of your cash value, not your creditworthiness.

Cons of taking out cash from a life insurance policy

• A lower death benefit: Withdrawing funds reduces the amount of your cash value and your policy's death benefit. Similarly, any loan amount you don't pay back is subtracted from the death benefit.
• Withdrawal or loan may not be an option: You can't access money from your whole life policy unless there is sufficient cash value in your account, which takes time to build. If you need money shortly after enrolling in your policy, you may not have the accumulated funds to borrow or withdraw. Rules regarding how much money you can borrow will also vary by insurer.
• Your insurance policy could lapse: When you pay back a policy loan, you must pay interest on the borrowed amount. If you borrow a substantial amount and accrue interest that eclipses your cash balance, your policy could lapse and be closed by your insurer. In that case, your loan balance could be considered taxable income, leaving you accountable for a potentially large tax bill.

Alternatives to cashing out life insurance

If you don't want to use your life insurance for cash, consider these alternatives. Using one of these options may allow you the money you need without risking your coverage.

• Personal loan: Depending on your credit, you may qualify for a personal loan with a competitive interest rate.
• 0% introductory APR credit card: Some credit cards offer the chance to accrue no interest for a given period (typically 12 to 18 months). Just be sure you can pay off the credit card balance before the introductory period expires and you start taking on interest at the regular rate.
• Home equity loan: Home equity loans allow you to access your home's equity for cash, but you'll likely be on the hook for closing costs that range from 2% to 5% of the loan amount. Educate yourself about the potential risks of a home equity loan, including the risk of a foreclosure on your home if you fail to make your payments.
• Cash-out refinancing: If eligible, you can take out a new mortgage loan larger than the amount you currently owe on your home, then pay the initial loan and take the difference between the two as cash. This may be an alternative way to access a large sum of cash.
• Reverse mortgages: A reverse mortgage permits older homeowners (62 and above) who have completely paid off or paid off most of their mortgage to take out a portion of their home's equity. This would qualify as tax-free income, and you could wind up getting a substantial sum if you don't owe much and/or your home's value has risen since you initially purchased it. 

Whether you decide to get cash out from your life insurance policy or not, take steps to build an emergency fund that covers your living expenses for at least three to six months. A sufficient emergency fund can help cover a financial crisis without having to borrow money from your life insurance policy or elsewhere.