Can You Use Life Insurance While Alive? What to Know Before Cashing Out
Life insurance policies are essential for many individuals hoping to protect their family members from financial damage upon the policyholder’s passing. However, paying life insurance premiums is challenging for many people, especially during financial turbulence.
When financial issues arise, many people ask: can you use life insurance while alive? The answer is yes; policyholders can cash out their life insurance policy for a lump sum–however, this decision isn’t always wise.
To help you understand how you can use life insurance while alive, we’ve compiled the ultimate guide to understand the purpose of life insurance, how you can use your life insurance funds, and what to expect when you cash out early.
Does My Type of Life Insurance Accumulate Cash?
First, it’s essential to understand that not every type of life insurance will accumulate cash. Only permanent life insurance policies accumulate cash, while term life insurance provides living benefits but does not build cash over time.
Below is a breakdown of the permanent life insurance policies that accumulate cash to determine whether your type of life insurance can be used while alive.
Whole Life Insurance
As with other types of permanent life insurance, whole life insurance policies include a helpful cash value component, allowing individuals to borrow funds against an accumulated cash value within their policy. Whole life insurance provides coverage and includes a savings component with a fixed interest rate, allowing the policy to accumulate cash.
With a whole-life policy, you can withdraw loans from your existing cash value funds and pay these loans over time with interest. If the policyholder passes away before the loans are paid, the remaining amount due is extracted from the beneficiary’s payout.
Universal Life Insurance
This type of permanent life insurance covers a policyholder for the duration of their life while including unique benefits not found with whole life insurance. Universal life insurance builds cash over time, allowing policyholders to maintain a flexible death benefit.
The cash value interest rate for universal life insurance is not fixed. This policy could evolve into a zero-cost policy, meaning individuals can choose to surrender their policy and receive the premiums back before its expiration date.
Ways to Access Cash From Your Life Insurance Policy
There are various ways to access cash from a life insurance policy, and each option comes with unique benefits and risks. Let’s break down five ways to access cash from your life insurance policy to consider before making a decision.
1. Withdraw Money
The first option to consider when attempting to access cash from your life insurance policy is to withdraw money. After your policy builds cash, you can withdraw money from your accumulated cash value. This money isn’t typically subject to income tax, provided the policyholder does not withdraw an amount exceeding the money paid into the policy.
Though this is a valuable option, there are risks associated with withdrawing money from your life insurance policy. For instance, your death benefit amount will lower, and the interest rate you can earn on your cash value will reduce.
2. Take Out a Loan
Another option to access money from your life insurance policy is a loan. Your life insurance company typically allows you to borrow through your policy, provided the loan amount does not exceed your policy’s cash value. If the policyholder passes before repaying the loan in full, the remaining balance due, along with interest, is taken from the death benefit.
Taking out a loan on your life insurance policy may be a valuable option if you’re in a situation where you need cash momentarily but want to keep your death benefit. Unlike personal loans, these loans won’t require you to have your credit checked.
3. Surrender Your Policy
Canceling your insurance policy is another option for cashing out. Though surrendering your life insurance policy means you’ll no longer have insurance coverage, you can turn to this method to receive the total cash value of your policy minus existing fees and penalties.
However, surrendering your policy also means you’re surrendering your death benefit. A surrender value cash payment, though helpful in the short term, includes significant fees and is typically reserved as a last resort option.
4. Sell Your Policy
Selling your life insurance policy is possible through life settlements, which allows you to claim your policy’s cash value and end your premium payments. Though it is a viable option, selling to a life settlement broker means you will lose most of your death benefit and incur additional fees.
Furthermore, the amount you sell your policy for will be significantly lower than your death benefit, and the additional taxes can make selling your policy expensive in the long run. Selling also means you won’t have life insurance coverage anymore, meaning that it is best left as one of your last resorts.
5. Use a Living Benefit Rider
This option is available regardless of whether you have permanent or term life insurance. Living benefit riders, such as long-term care riders, are available to add to insurance policies and access living benefits.
However, living benefits are not included in all insurance policies, and you might not qualify for additional riders if you are not suffering from a chronic, terminal, or critical illness, or if you are certain that won’t need access to long-term care benefits in the future. These options are explained further below.
How Do Living Benefits Work?
Life insurance that includes living benefits is helpful in many situations and allows policyholders to get cash from their policy while still alive. However, there are specific qualifications you’ll need to meet before you can access these benefits.
If you choose to get cash from your policy through living benefits, ensure that you meet the following criteria:
- To qualify for a chronic illness benefit: chronic illness riders are available only for policyholders diagnosed with an illness that prevents them from performing at least two of the following six activities of daily living: eating, bathing, toileting, transferring, continence, and getting dressed.
- To qualify for a long-term care benefit: long-term care benefits are available for individuals whose death benefit amount isn’t enough to cover a costly medical expense for prolonged treatment, such as facility stays, adult daycare, and home healthcare services.
- To qualify for a terminal illness benefit: a terminal illness benefit rider applies to individuals diagnosed with an illness with a life expectancy between six months and two years. These are often, but not always, included in your policy automatically. Always check with your insurance company and a trusted advisor to ensure this is included. While helpful, a terminal illness rider often includes a waiting period before you can access your funds.
- To qualify for a critical illness rider: critical illness riders are available for policyholders dealing with specific, often unexpected illnesses that incur a significant medical expense and reduce life expectancy. These illnesses might include strokes or heart attacks.
Do I Need to Pay Taxes When I Cash Out My Policy?
You will likely not need to pay taxes when cashing out your life insurance policy. However, there are exceptions to this rule. Below are the two situations where you must pay taxes when cashing out your insurance policy.
- The amount you cash out goes over the total amount of premiums you’ve paid. If this situation occurs, you might be required to pay additional surrender fees and financial penalties.
- The second situation where you will pay taxes when cashing out is if you cash out while still having unpaid loans from your insurance policy. For instance, if your policy lapses before you’ve paid your loan, you will pay income taxes on the current amount owed.
Should I Cash Out My Life Insurance Policy?
Though numerous risks are associated with cashing out your policy early, some situations could warrant this decision. Determining whether to cash out your policy is a significant choice that shouldn’t be jumped into without taking time to consider the implications seriously.
If you no longer need your life insurance policy, cashing out is an option–however, you’ll need to forfeit the long-term benefits of maintaining a policy. If you need cash urgently, you might consider cashing out.
Depending on the amount you need and whether you want to maintain coverage, different cashing-out options might be more suitable than others. Small sums are best accessed through small loans or withdrawals, while more considerable sums may require you to sell your policy.
If you can benefit from cashing out your policy, consult further guidance from your attorney, financial advisor, or certified public accountant.
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