Can I Cash Out My Life Insurance Policy?

Consider the penalties before making a decision.

Cashing out on a good life insurance policy is a big deal. Doing so generally decreases the death benefit offered by a policy. Typically, people choose to cash out when they have few, if any, other options. 

If you own one of the following policies, there are a few ways you can cash out.

Which policies can I cash out?

You can cash out cash-value life insurance policies like whole and universal insurance. These policies build up cash reserves over time, and the policyholder may choose to tap these reserves by withdrawing cash, borrowing against the policy, or canceling the policy.

Term life insurance policies do not build cash reserves over time and cannot be cashed out.

If you're considering investing in a life insurance policy because you can cash it out, there may be more profitable ways to invest. For example, the stock market typically offers better returns than a life insurance policy.

How do I cash out?

You can cash out a life insurance policy in a few ways:

• Withdraw cash
• Borrow against a policy
• Cancel a policy

Here's how each of these options works.

Withdraw cash

Generally, you can withdraw some cash tax free from a qualifying policy. Typically, there are consequences to doing so. For example, withdrawals over a certain threshold may be taxed. Also, insurance may pay beneficiaries less cash after your death or bump your monthly premiums.

Borrow against a policy

Most policies allow you to borrow against your policy's built-up cash reserves. The greater your reserves (and the longer you've been paying premiums), the more money you're able to borrow.

There are a couple of things to consider before borrowing against a policy, however. First, the policyholder may have to pay interest on their loan. Second, the loan balance may reduce the amount beneficiaries earn in the event of the policyholder's death.

Cancel a policy

Canceling a life insurance policy gives you access to cash reserves built up by premiums and interest. You can freely use the money you get from cashing out this way.

Once you cancel your policy, your insurer won't pay your beneficiaries in the event of your death. Canceling a policy might make it more difficult to restart the same policy later on.

Any money cashed out this way is taxable. Plus, the insurance company may pile on additional cancellation fees. Check your policy for details.

How should I cash out?

Withdrawals or loans may be tax free. Plus, beneficiaries still get paid in the event of the policyholder's death. However, canceling a policy may be a viable option if someone needs to withdraw the total value of their account.

If you want to access money quickly without reducing the value of your death benefit, you have other options. For example, taking out a low-interest personal loan won't affect your death benefit. Neither will money withdrawn from an emergency fund.

Look over your long-term plans, including your budget, before you decide. Cashing out a life insurance policy may be the best move for you, but be sure to consider all your options.