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How to Use Life Insurance While Alive

The benefits of life insurance aren't exclusive to beneficiaries. You may wonder, "Can I cash out my life insurance policy?" The truth is, you can. Your life insurance policy can be an asset to you while you're still alive because it can serve as a financial resource with some types of life insurance policies. However, withdrawing funds from your life insurance policy or borrowing against it can have tax implications and affect your death benefit.

Key takeaways:

Can you cash out a life insurance policy?

Yes, you can cash out a life insurance policy by withdrawing some accrued funds or surrendering the policy entirely. However, this is only possible with policies that feature a cash value component. Policies that don't build in cash value don't offer an option to cash out because there's nothing to cash out — either the death benefit is disbursed to your beneficiaries, or the policy is canceled without any funds being released.

How does cash value grow?

Cash value is a feature of life insurance you can cash out. If you have a policy with a cash value feature, some of your premium payments will go toward the cash value account. Generally, your policy will begin to gain cash value after you've held the policy for two to five years. The cash value will grow at a guaranteed interest rate or by stock market performance.

Purchasing a policy with this feature won't result in immediate access to your cash value account once it begins building. It can take decades for the funds to grow into an amount that's substantial enough for you to borrow against or use for major expenses such as buying a home and covering your child's college tuition.

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Do you pay taxes on life insurance cash out?

Cash value accumulates tax-free, but taxes may go into effect when you withdraw funds from your account. This may depend on the amount you take out of your account. For instance, if you withdraw less than what you contributed through premiums, you may not owe taxes. However, if your withdrawal exceeds what you contributed, then taxes can apply.

If you've withdrawn in excess of your contributions, you'll be taxed on the interest or capital gains, but not the entire amount. Any interest or capital gains will count as taxable income once liquidated.

However, there is an exception if you use your cash value to increase the death benefit instead of accessing the funds yourself. The death benefit is tax-free, regardless of whether you increase it at a later time. In other words, funds from a life insurance policy are taxable for you, but a death benefit that's passed down will be tax-free for your beneficiaries.

How to cash out a life insurance policy

There are three approaches as to how to cash out life insurance while alive, and each have their own advantages and disadvantages:

  • Withdrawing from your account
  • Getting a loan against your policy
  • Surrendering your policy

Withdrawal involves taking money directly from your cash value. You don't have to pay anything back. It can be tax-free if kept to a smaller amount. However, this will be deducted from your death benefit, and your beneficiaries will receive the original death benefit minus what you've withdrawn.

Some may use the terms "loan" and "withdrawal" interchangeably, but there is a significant distinction between them. When you get a loan, you'll owe your insurer the amount you received plus interest. The death benefit will be unaffected if you repay your insurer in full. However, if the loan isn't fully repaid, the death benefit will be reduced by the loan's outstanding balance.

Surrendering your policy subjects you to taxes, the policy's surrender charges, and possibly other fees. You won't receive the total amount you had in cash value. Additionally, your beneficiaries won't receive the death benefit.

How long does it take to cash out life insurance policy?

The amount of time it takes to cash out a life insurance policy will depend on when your policy begins accumulating cash value. Policies also vary when it comes to withdrawal rules.

Can you cash out a whole life insurance policy?

Whole life insurance policies are lifelong, never expiring, and never require renewal. Aside from this, one of life insurance's most significant selling points is its cash value component. A portion of your premiums will go toward this cash value account, which continues to build as you pay premiums. Generally, more premiums are allocated to your cash value, but this will decrease over time. Eventually, the funds in this account will be substantial enough to be a valuable financial resource. Generally, whole-life policies have a cash value that grows at a guaranteed interest rate.

When to cash out a whole life insurance policy

Due to the gradual accumulation process, holding off from cashing out life insurance until several years (perhaps decades) after getting a whole life insurance policy is best. There needs to be more than a year's worth of contributions through premiums to elevate your financial status considerably. The longer you wait, the more you'll be able to retrieve from your overall cash value and the more use it will have for you.

Cashing out is best reserved for emergency situations, as cashing out can have tax consequences and affect your death benefit. And if you choose to surrender your policy, that could also mean getting less than you accumulated while no longer having a death benefit.

Do all types of whole life insurance build cash value in the same way?

Whole life insurance policies come in different forms, and this affects how the cash value grows, which can also affect how much you'll be able to access.

If you get a universal life insurance policy, the cash value has minimal growth, but the cash value isn't the primary reason individuals purchase this type of whole-life policy. While you can withdraw, its selling point lies in adjusting premiums and death benefits as needed.

However, if you want to maximize your cash value, variable and indexed life insurance have more potential for growth. Portions of the funds that go toward variable life insurance premiums are placed into investment accounts. With indexed life insurance, the funds go into a stock market index. While these two policies pose the most significant growth potential, they're also not risk-averse, as cash value depends on market conditions.

Can I cash out my term life insurance policy?

Term life insurance generally doesn't feature a cash value component, thus not allowing for cashing out or borrowing against the policy. With term life insurance, coverage can last anywhere from five to 30 years. Some policies renew annually. Since cash value can take decades to build to a substantial amount, it wouldn't be an optimal feature for a policy that charges low premiums and lasts for a shorter period.

Return of premium life insurance is the exception to this. Return of premium policies are term policies that last 20 to 30 years and feature a cash value component. Policyholders can borrow against it as it builds while the policy is active. It is a way to get a term life insurance cash out. The other benefit is that, unlike most term life policies where the policyholder receives nothing after the policy lapses, the return of premium policies will refund the premiums paid after the term ends.

Cash out group life insurance

In most cases, group life insurance doesn't allow policyholders to cash out, as most group life insurance policies are term life policies. And since this coverage is usually through an employer, you could lose your policy before the term ends if you lose your job or the company goes out of business. Although group coverage is convenient because of its low price, it shouldn't be the only life insurance policy you have.

But not all group policies are alike, and your employer may offer whole life group coverage. If that is the case, then your whole life policy would function the same as an individual one - lifelong and with the option to cash out.

Can I use my life insurance policy to get cash besides through the policy itself?

You can use your life insurance to obtain funds from other sources. You can use your life insurance policy as collateral when getting other types of loans. Each lender will have different rules regarding what kind of life insurance you need to qualify for a loan, whether you can use an existing policy as collateral, and the death benefit needed to get approved.

If you get a life insurance policy for securing a loan, you should still name beneficiaries as you would if you were to buy a life insurance policy for the sake of providing your loved ones with a death benefit. If you pass away before the loan is paid back, your lender will take the amount you owed at the time of death and deduct that from the death benefit, and what remains of the death benefit will be transferred to your beneficiaries.

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