After more than two decades in financial services and over a decade as an independent agent, I’ve helped countless clients navigate one of the most important decisions they can make about their life insurance: how to access the value they’ve built up in their policies. Whether you’re facing a financial emergency, planning for retirement, or simply reassessing your insurance needs, understanding your options for cashing out a life insurance policy is crucial.
For a complete overview, see MPI explained in detail.
The truth is, many people don’t realize the flexibility that certain types of life insurance policies can provide. When properly structured, these policies can serve as more than just death benefit protection—they can become a valuable financial tool during your lifetime.
Understanding What “Cashing Out” Really Means
Before we dive into the specific methods, it’s important to understand that “cashing out” a life insurance policy can mean different things depending on your situation and goals. Some people want to access money while keeping their policy in force, while others are looking to terminate the policy entirely and walk away with whatever value they can get.
The options available to you depend primarily on what type of policy you own. Term life insurance policies typically don’t build cash value, so your options are limited. However, permanent life insurance policies—including whole life, universal life, and indexed universal life—often accumulate cash value that you can access in various ways.
I’ve worked with hundreds of clients over the years who were surprised to learn they had options beyond simply letting their policy lapse. The key is understanding which option makes the most sense for your specific situation.
Policy Surrender: The Complete Cash-Out Option
The most straightforward way to cash out a life insurance policy is through a complete surrender. This means you’re terminating the policy entirely and receiving the cash surrender value from the insurance company.
When you surrender a policy, the insurance company will calculate your cash surrender value, which is typically your accumulated cash value minus any applicable surrender charges. These surrender charges are particularly common in the early years of permanent life insurance policies and can significantly reduce the amount you receive.
Here’s what happens during a policy surrender:
• The insurance company cancels your policy permanently • You lose all death benefit protection • You receive the net cash surrender value (cash value minus any loans and surrender charges) • You may owe taxes on the gain portion of the surrender value
From my experience, policy surrender makes the most sense when someone no longer needs life insurance protection and wants to access the full cash value. However, I always encourage clients to carefully consider the tax implications before moving forward.
Policy Loans: Accessing Cash While Keeping Coverage
One of the most flexible options for accessing cash from your life insurance policy is taking a policy loan. This feature is available with most permanent life insurance policies that have accumulated cash value.
Policy loans work differently than traditional bank loans. You’re essentially borrowing against your own cash value, using it as collateral. The insurance company lends you money, and your cash value secures the loan. This means your cash value continues to grow even while you have an outstanding loan balance.
The advantages of policy loans include:
• No credit check required • No mandatory repayment schedule • Interest rates are typically competitive • Your death benefit remains in force (minus any outstanding loan balance) • When properly structured, loans are generally not considered taxable income
I’ve helped many clients use policy loans for everything from emergency expenses to supplemental retirement income. The key is understanding that if you don’t repay the loan and interest, it will reduce the death benefit available to your beneficiaries. In extreme cases, if the loan balance grows too large relative to the cash value, it could cause the policy to lapse.
Partial Withdrawals: Taking Some Cash Value
Many permanent life insurance policies allow partial withdrawals, where you can take out a portion of your cash value without borrowing against it. This permanently reduces both your cash value and death benefit, but it can be a tax-efficient way to access some money when you need it.
The tax treatment of partial withdrawals generally follows what’s called the “FIFO” method—first in, first out. This means withdrawals are typically considered a return of the premiums you paid first, which aren’t taxable since they were made with after-tax dollars. Once you’ve withdrawn an amount equal to your total premium payments, additional withdrawals may be subject to income tax.
Partial withdrawals make sense when you need some cash but want to maintain life insurance protection. However, it’s important to understand that reducing your cash value will impact the policy’s future performance and death benefit.
Life Settlements: Selling Your Policy
A life settlement involves selling your life insurance policy to a third party for more than its cash surrender value but less than its death benefit. This option is typically available to older policyholders (usually 65 and older) who no longer need or want their life insurance coverage.
The life settlement process works like this:
• A life settlement company evaluates your policy and health status • They make an offer based on your life expectancy and the policy’s value • If you accept, you receive a lump sum payment • The settlement company becomes the new owner and beneficiary • They pay future premiums and collect the death benefit when you pass away
I’ve seen life settlements provide significantly more value than policy surrenders in certain situations, particularly for older clients with substantial policies they no longer need. However, this option requires careful consideration of privacy concerns and the impact on your estate planning.
Accelerated Death Benefits: When You Need Care
Many modern life insurance policies include accelerated death benefit riders, which allow you to access a portion of your death benefit if you’re diagnosed with a qualifying chronic, critical, or terminal illness. While this isn’t technically “cashing out” in the traditional sense, it’s an important option to understand.
These living benefits can provide crucial financial support when you need it most. I had a client years ago who bought a term policy with living benefits. When she was later diagnosed with ALS, she was able to access 90% of her death benefit while still living. She used that money to take a trip with her family before she passed. That’s the kind of moment that reminds me why this work matters.
Tax Implications You Need to Know
The tax consequences of cashing out a life insurance policy can be complex, and they vary depending on which method you choose. Generally, you’ll owe income tax on any amount you receive that exceeds what you’ve paid in premiums (your “basis” in the policy).
For policy surrenders and withdrawals, the taxable amount is typically the difference between what you receive and what you’ve paid in premiums. Policy loans, when properly structured, are generally not considered taxable income as long as the policy remains in force.
However, there’s an important exception called the Modified Endowment Contract (MEC) rule. If your policy is classified as a MEC due to premium payments that exceeded certain limits, withdrawals and loans may be subject to income tax and potentially a 10% penalty if you’re under age 59½.
I always recommend consulting with a tax professional before making any decisions about cashing out a life insurance policy. The tax implications can be significant, and proper planning can help minimize your tax burden.
Making the Right Decision for Your Situation
Deciding how to cash out a life insurance policy—or whether to cash it out at all—depends on your individual circumstances. Throughout my career, I’ve learned that there’s rarely a one-size-fits-all answer.
Consider these factors when evaluating your options:
• Your current financial needs and goals • Whether you still need life insurance protection • The tax implications of each option • Your health status and life expectancy • Alternative ways to meet your financial needs • The impact on your beneficiaries
I’ve helped hundreds of people who were told “no” by other agents or carriers find the coverage they needed, and I’ve also helped many clients optimize the policies they already owned. Sometimes the best solution isn’t cashing out at all, but rather adjusting the policy or exploring other financial strategies.
When Professional Guidance Makes Sense
The decision to cash out a life insurance policy can have lasting financial implications. Working with an experienced insurance professional can help you understand all your options and make an informed decision based on your specific situation.
As someone who’s been in this industry for over 20 years, I’ve seen the good, the bad, and everything in between. I wish more people understood that not all insurance professionals are the same. Some will pressure you to make quick decisions, while others will take the time to understand your situation and provide honest guidance.
My approach is to understand what you’re looking to accomplish and help you achieve that in the most efficient way possible. Sometimes that means cashing out a policy, sometimes it means keeping it, and sometimes it means making adjustments to better serve your needs.
If you’re considering cashing out a life insurance policy, I encourage you to explore all your options before making a final decision. What seems like the obvious choice isn’t always the best one, and with proper guidance, you might discover alternatives you hadn’t considered. Whether you need immediate cash, want to optimize your existing coverage, or are planning for retirement, understanding your options is the first step toward making a decision you’ll be comfortable with for years to come.
Contact Heritage Life Solutions today to discuss your specific situation and explore the options available with your life insurance policy. With over 20 years of experience in financial services, I’m here to provide the honest, professional guidance you deserve.
