Cashing out life insurance: what are the advantages and limitations?
Although one does not typically buy a permanent life insurance policy just to withdraw its cash value some time later, there are situations that require accessing funds quickly. Those funds that can be withdrawn represent the cash value of your life insurance. The cash value is calculated according to the sum of premium payments to date, insurer fees and interest.
In the event you find yourself in this situation, is it possible to make a partial withdrawal of life insurance to recoup some of the money invested or should you necessarily cancel the policy and receive its full cash value? In terms of life insurance cash out, it all depends on the contract but usually both are possible, with their advantages and limitations.
Advantages and limits of cashing out life insurance
Life insurance withdrawals have many advantages such as:
- The ability to easily withdraw funds at any time. Simply fill out a form to obtain the desired amount immediately, within the limit of the cash value.
- This possibility is available mainly for universal life policies, as whole life insurance policies generally have no cash value in the early years.
- The freedom to use the funds as you see fit. Unlike some loans, you are not required to justify how you spend the withdrawn money. You can use it for medical expenses, to help a loved one in need or to travel the world.
However, be aware of its limitations:
- The agreement of an irrevocable beneficiary is required. Without their agreement, it is impossible to access the funds.
- Withdrawals are final: all subsequent payment will not count as reimbursement.
- The withdrawn money is taxed. Of course, only the portion that generates investment returns is subject to tax, as the portion dedicated to insurance benefits is tax-free.
- The death benefit is reduced: the withdrawal amount will be deducted from the compensation paid to the beneficiary in case of death.
- The obligation to cancel the policy in some cases. Indeed, if the contract does not allow partial withdrawal, you are forced to cancel your policy.
- Withdrawals impede growth of the current and future cash value of your policy.
What if you could get money without touching your life insurance?
There are other ways to use your life insurance to collect money without removing funds from your policy or cancelling the contract.
The policy loan
This solution has three major advantages. It allows the insured to access funds without withdrawal fees and to reimburse the loan at any time. Loans are not taxed up to the adjusted cost base. Beyond that amount, they are subject to a tax deduction if they are reimbursed.
But this option also has drawbacks: it can cause the policy to be revoked or force the insured to make additional payments if the cash value were to fall below the loan amount. It can also slow down the growth of the cash value.
The secured loan
This is a loan secured by life insurance. Generally, it is possible to obtain funds up to 90% of the cash value. This solution lets you collect tax-free money without affecting tax credits, with no effect on the insurance policy. In return, the policy has to remain in force until full repayment of the loan.
Need to access funds quickly? Study the different options available to you before making your choice. Because if you only need a portion of the cash value, opt for the policy loan or secured loan. They will allow you to get money while keeping your policy intact and paying less tax.