What Are the Tax Consequences of Cashing In a Whole Life Insurance Policy?

Did you know you can sell all or a portion of a life insurance policy, even term insurance?

(4 minute read)

If you’re considering surrendering or selling your life insurance policy, it’s important to understand what, if any, taxation consequences you should prepare for. Not only will understanding what to expect help you to make a better, more informed decision regarding your life insurance policy, but it can also help you prepare for those tax consequences as best as possible.

In fact, at Life Settlement Advisors (LSA), one of the most frequent questions we hear is about taxable gains on life insurance policies. In our latest blog, we’re exploring whole life insurance policies, including what happens when you cash out a whole life insurance policy, tax consequences,  and other options that may be available to you. 

What Happens If I Cash Out My Whole Life Insurance?

Whole life insurance policies may be cashed out in full via a surrender. Or, rather than surrendering the entire policy, you may also choose to cash out a partial amount of money. There’s also a third option of selling your life insurance policy via a life settlement—more on this later.

Before diving into each of these options, let’s quickly discuss whole life insurance policies. Whole life insurance policies have two components. First, like all life insurance policies, you have the face value or death benefit. This reflects the amount of money your beneficiary will receive. 

Unique to permanent policies like whole life insurance, there is also the cash value, which is essentially a savings or investment account. This is the part that makes a cash out option available to policyholders. Over time, you can build out this savings account on a tax-deferred basis. It is important to note that when you cash out a whole life insurance policy, you will not receive the face value. Instead, you receive the cash value, less any required fees.

What Happens When You Surrender a Whole Life Policy? 

When you surrender your life insurance policy for the cash value, you will receive a one-time payment for the cash value of your policy, minus any surrender fees charged by the life insurance company. In return, your policy will be terminated and your beneficiaries will not receive a death benefit. For whole life insurance, the cash surrender value of your life insurance may be taxable.

What Happens When You Withdraw a Portion of the Cash Value of a Life Insurance Policy

The amount you can withdraw may vary based on your policy, the life insurance company, how much the cash value is, and how long you have held your policy. Certain types of policies may not allow for withdrawals, or may charge an early withdrawal fee if you are under a certain age.

Once you settle on an amount to withdraw, you will receive a one-time payment. Some withdrawals may have unintended consequences, such as reducing the death benefit, reducing the cash surrender value, or even increasing premiums in certain situations. Before making a withdrawal, it is important to understand if any of these situations will apply to you. Like a full surrender, you may be subject to taxation on the amount you take out.

What Are the Tax Implications of Cashing Out a Whole Life Policy?

Whether you decide to cash out your whole life insurance policy or make a partial withdrawal, there may very well be tax implications. It depends on how much money you’ve paid in premiums and how high the cash value is.

Essentially, you can withdraw the amount of money equivalent to the amount you’ve paid in premiums tax-free. However, if the cash value—the amount you receive either via withdrawal or surrender—is higher than what you’ve paid in premiums, you may need to pay income taxes. Those taxes would only apply to the amount over what you’ve paid in premiums.

Let’s take a look at an example. Say you have a whole life insurance policy with a cash value of $15,000. You’ve paid a total of $10,000 in premiums. That means you could be taxed on the additional $5,000. On the other hand, if you decide to simply withdraw $4,000 from the same policy, that amount would not be taxable as it does not exceed the amount you’ve paid in premiums.

Wondering, “How do I avoid tax on the life insurance cash value?” Ensure the amount you withdraw doesn’t exceed the amount you’ve paid in premiums. Otherwise, there is likely no way to avoid paying some taxes. As always, you should speak with a financial professional to fully understand how this may impact your financial situation.

What Other Alternatives Are There to Cashing Out Your Policy? 

Many individuals find that selling their whole life insurance policy via a life settlement can be more lucrative than surrendering it for the cash value. With a life settlement, you would sell your policy to a third party investor. You receive a one-time cash payment—often much higher than the cash surrender value of your policy. In return, the buyer takes over paying the premiums on your policy and will receive the death benefit when you pass.

At Life Settlement Advisors, we help seniors, their families, and their financial advisors understand the process of life settlements and determine if it’s the right fit. Find out if you might qualify for a life settlement with our easy-to-use life settlement calculator

Did you know you can sell all or a portion of a life insurance policy, even term insurance? Selling an unwanted life insurance policy is no different than selling your car, home, or any other valuable asset that will create immediate cash. Contact us today to learn more.

Get in touch with Life Settlement Advisors today to take the first step toward converting your policy into cash.

Leo LaGrotte
Life Settlement Advisors

Get in touch with Life Settlement Advisors today to take the first step toward converting your policy into cash.
Life Settlement Advisors
Leo LaGrotte
At Life Settlement Advisors, we strive to be a voice of confidence and assurance for our clients. Our goal is to educate you about the life settlement process so you can make an educated decision about whether it is right for you.