Why you shouldn’t cash in a life insurance policy

If you own life insurance with cash value, like a whole life or universal life policy, there are ways you can access and receive some or all of that cash value in times of need, but it is only advisable to do so if you have no better options.

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Can you cash in a life insurance policy?

Life insurance is primarily designed to protect your family financially after you are gone. However, many permanent or long-term policies also provide a “cash value” that you can access during your life in times of need. Perhaps there is a medical emergency. Maybe you need extra funds to help pay a child’s college tuition. Or you may even decide that you no longer need your life insurance. 

In difficult financial times, it’s vital that you do what is right for you and your family, and that may include cashing in your life insurance policy. But be aware that doing so can have significant financial implications for your family as doing so will reduce the death benefit and the available cash surrender value if you need to surrender your policy.

If your life insurance policy has a cash value, there are a number of ways you can access it while you are still alive, if it becomes necessary.

Term life does not have cash value

Term life policies do not include cash value, because they are meant to cover a particular time period only and then end. This means that you won’t be able to cash in a term life policy. It may be possible, however, to convert your term policy into a whole life policy that will allow you to build cash value. Talk to your financial professional or an agent to go over your options.

Can I access the full amount of my policy?

No. A policy that has a $50,000 life insurance benefit cannot be cashed in for $50,000. That amount can only be collected by your beneficiaries when you pass, provided you didn’t access any cash value. The money you will be able to cash in will depend on how much cash value the policy has built, which is almost always considerably less than the total and can vary dramatically depending on how you’ve structured your life insurance policy.

Are there penalties on a life insurance payout?

Generally, yes. Depending on how you choose to get your life insurance payout, you will likely be subject to some fees and may owe taxes. Each policy will be different, and it’s important to understand all the details before you take this step. In addition, if you pull out too much or can no longer make premium payments, you may lose your coverage completely.

Alternatives to cashing in your life insurance

There are many ways to procure immediate cash without tapping into your life insurance policy and potentially putting your coverage at risk. It could be wise to look into other options first, like home equity loans, personal loans, borrowing against a 401(k), or even a 0% APR credit card. Depending on your present and future financial needs, these could be better options than cashing in your life insurance.

Cash value explained

Almost all forms of permanent or long-term life insurance grow a cash value over time. It’s an additional benefit that can help with unforeseen costs while you are still alive. The amount of cash value your life insurance may hold depends on the premiums you pay, the length of time you’ve held the policy, and any specific details or add-ons you may have chosen when you purchased your policy. 

Part of the premium converts into cash value

Each time you make a premium payment on a permanent or long-term life insurance product, a portion of it goes into a fund. This is generally a small percentage, but different insurance policies and features can change the contribution amounts.

Your cash value grows over time

The cash value of your life insurance policy earns interest, as well. As you continue to make contributions, the more you put in, the faster it can grow and the more it’s ultimately worth. Some add-ons, called “riders” can help your cash value grow faster than it normally would.

Reducing the cash value reduces your life insurance benefit

If you borrow or withdraw from you cash value, the benefit of your life insurance will go down. That means your beneficiaries, likely your family, will receive a reduced payment when you pass. You’re basically converting money for them later into money you can use now. Consider this tradeoff carefully when deciding whether to cash in your life insurance. 

How do I cash in a life insurance policy?

There are a few main ways to get cash value out of your policy. The option that best suits your situation will depend on how much you need and how important it is to keep your policy coverage. Your specific life insurance policy will also have rules on how, when, and how often you can cash in. Be sure to consult a financial professional or an agent before taking this step, so you fully understand what fees, taxes, and penalties you might be subject to.

Use the cash value to pay your premiums

If you are struggling to keep up with premiums but want to keep your life insurance policy in place, there are ways you can apply the cash value to help pay them. This is only a short-term solution, as draining the cash value will lower the overall benefits and could eventually cause the surrender of the policy. 

Make a partial withdrawal 

Depending on your life insurance policy and how it’s customized, you may be able to withdraw money directly from the cash value. Each policy is different, so you may or may not be subject to early withdrawal fees that affect your overall benefits.

Borrow against the policy

You can often take out a loan with the cash value of your life insurance policy as collateral. With any loan, however, you’ll be charged interest. If the loan isn’t paid before you pass, then it’s usually deducted from the death benefit, which means your beneficiaries will receive less than you intended.

Surrender the policy

This means functionally canceling your policy. If you do this, your life insurance coverage will end. You’ll generally receive most or all of the cash value of your life insurance policy, but it may be subject to surrender fees and federal income taxes. Any unpaid premiums will also be collected. 

Sell it to a third party

This is functionally the same as surrendering your policy. You will no longer have coverage. The amount you receive for selling your life insurance to a third party over simply surrendering it will vary depending on many factors. You may also be subject to large commissions and fees that reduce the amount you will receive. 

If you are considering cashing in your life insurance policy, the best thing you can do is talk to a trusted professional. We can help you go over all your options and find the path forward that’s best for your financial present and the future of your family. 


Want to learn more about life insurance? 

A New York Life financial professional can help determine what’s right for you.

"New York Life Insurance Company is the issuer of New York Life Whole Life. In Oregon, the Whole Life policy form number is ICC18217-50P (4/18)."