When the mortgage has been paid for, the kids are out on their own, and your retirement savings have been locked in, that is the time when most people think about cashing out their life insurance policy. There are several reasons why people decide at this point in their lives to cash out their life insurance. The bottom line is that the policy itself must qualify for cashing out.
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Table of Content
Firstly, Can You Cash Out Life Insurance?
Yes, you can cash out a life insurance policy if it has a cash value. To decide whether to cash out, you will need to know how it works.
There is the face value of the policy and the cash value. All policies that qualify to be cashed out will have both benefits. The face value is what your beneficiaries are paid if you should pass away. The cash value represents the money that you put into the policy with the premiums that you paid. While there are term and whole life insurance policies, it is one that has a cash value means that is what you receive if you take the money now.
Now that you know what you have, the next step is deciding which method of cashing out you want to choose.
Canceling or Surrender
When you have built up cash value in your life insurance policy, you can cancel or surrender it and get what you put in. This means that you can get the money put into the policy by your premiums minus any fees. You will no longer have a life insurance policy and no benefits from it to give to your beneficiaries.
This action is usually one of last resort. Most people do not want to cash out their life insurance policies fully. This is why there are alternatives available.
Instead of cashing out the policy, you can borrow against it. This means that you are using the cash value of life insurance as collateral for a loan. This method of getting money from your life insurance offers advantages.
- Retains the Policy
- Get Only the Cash You Need
- Allows for those with Poor Credit Ratings to Receive Larger Loans
When you borrow, you keep the policy intact. It is only when you default on the loan that it is cashed out for its value. If you borrowed less than the cash value, you might retain the remainder depending on the rules of the insurance company.
Some policies allow for a limited withdrawal of the cash value. The withdrawal is based on the amount of cash you put in. What makes this a popular option is the money you pull out is non-taxable. This is because just like putting money into a savings account, you have already paid the taxes for it. However, if you pull out more than the cash value, now you are obtaining taxable new money.
The downside is that your death benefit will be reduced. This means that you should carefully consider withdrawal as changes to your life may have an unforeseen impact.
Stopping Premium Payments
You can use the cash value built up in the policy to pay your premiums for a short time. This is when you have an unexpected event that will not allow you to pay your monthly premium. Such events include an unexpected car repair, medical expense, or other financial issues. The downside is that the cash value of your policy is reduced, but it does remain intact.
When to Cash Out Your Life Insurance?
There are times when cashing out your life insurance policy is the best option. This is especially true if you do not have any other options. However, for most people cashing out their policies is a wise financial decision.
- Life Changes
- Need Money for an Emergency
- Want to Purchase Something New
- Policy is Fully Paid
Changes in your life are the most common and practical reason to cash out an existing policy. Many people who obtain life coverage when they are young have more substantial death benefits that cover their families. When you no longer have kids to take care of, a mortgage to pay off, and enough retirement savings built up, the need for a significant death benefit goes away.
Many who cash out will use the money to purchase smaller policies, such as funeral insurance to cover the burial, plot, and other expenses associated with their passing. The rest of the money is put into a savings account or invested where it can be better used.
If your life insurance policy is fully paid up, then you can cash out what you have put into it. Once your policy has earned a cash value, then you can cash it out at any time.
Here is the suggestion:
Cashing out a policy to pay off an emergency, such as an unexpected medical bill, repair to the home, or other large payment is generally not encouraged. Instead, you may want to borrow against the policy or find another source of money.
How to Avoid?
There are a few ways you can avoid cashing out your life insurance policy if you need the money. What you choose will be based on your current situation.
- Borrowing Money from the Policy
- Stopping Premium Payments
- Finding Another Source of Money
- Using Your Credit to Borrow Money
When you borrow money against your life insurance policy, you keep the policy itself intact. As long as you pay the money back, you can keep the life insurance policy going. If you only need a small amount of money to pay off a bill, then stopping a premium payment and having it taken out of the cash value is a good option.
Which Types of Life Insurance Policies Can Be Cashed Out?
The answer is any policy that has a cash value. Policies that do not have a cash value cannot be cashed out. They cannot be borrowed against either because it cannot be used as collateral. Before you purchase any life insurance policy, you should find out if it has a cash value and whether it can be cashed out if needed.
Maximum Withdrawal: The maximum amount that can be withdrawn is the total cash value minus the fees and other costs associated with getting the money from the policy. Fees are imposed both as a service and as a discouragement to cash out the policy. Remember that the cash value is the total amount of money you have put into the policy through premiums. This does not include any interest that has built up over time.
Affecting Coverage: Your coverage will be affected by the amount that is removed from the policy. This means that your death benefits will be reduced. If you remove all the money, then the life insurance policy will be canceled.
Imposed Fees & Amounts: Each insurance company has its own set of fees that they impose when money is cashed from the policy. You will have to check with your insurance agent to understand the level of the charges. This usually depends on the type of policy, the amount of the benefits, the interest rate added, and the cash that has been put into the policy over time.
Your tax consequences will depend on the money that you take form the policy. If you only take out what you put in, then you will not suffer any consequences. This is because the money that is paid in by the premiums has already been taxed. Since money cannot be taxed twice, you will not be penalized when removing the cash from your life insurance. It works on the same principle as withdrawing money from your savings account that also has already been taxed.
If you take out more money than you put in, then it may be taxed. This is money that is added to the cash value of the policy, such as interest which builds up over time. You have yet to be taxed for that income, so taking it out means it will have to be accounted for on your tax forms. Many whole life insurance policies will add a small percentage to the money you have put in. This is just like the bank proving you with a percentage increase in your savings.
The longer your money is in such an account, the more interest it will build up. If you want to avoid any tax consequences, then only remove the amount of money that you put in with your premiums.
There are many benefits and risks to cashing out your life insurance policy. Before deciding to do so, be sure to look over all options. You may find that cashing out is the best choice. However, you may also find out that there are other options available that might be better suited to your needs.