Can You Cash Out a Life Insurance Policy?

Looking to cash out a life insurance policy? You may be able to, depending on the type of policy you have. Accessing the cash value could help cover your various financial needs. Learn more about the benefits and drawbacks before you access these funds.

No matter how financially prepared you are, sometimes you may face a situation where you need immediate access to cash. Whether you are facing an emergency, want to invest in a business opportunity, or need to supplement your income during retirement, you might be able to turn to your life insurance policy as a source of funds.

These real-life situations could happen to anyone and the accrued cash value in a life insurance policy may provide you with the financial protection you need. The good news is you can access the cash value in certain types of life insurance policies. However, you’ll need to understand the rules, risks, and financial implications before you tap into these funds.

Here, we’ll cover the types of life insurance policies that allows you to access the cash value, how to go about it, as well as the associated risks and considerations before making a decision.

Key takeaways

• With certain whole or life insurance policies, you can cash out or access the cash value of a life insurance before death.

• Borrowing, withdrawing or surrendering your policy are several ways you can access the cash value of a life insurance policy.

• The surrender charges or loan interest may reduce your payout.

• Accessing the cash value of a policy gives you faster access to funds, but you may forego future growth on the cash value and possibly reduce your death benefit.

• It may make sense to access the cash value of a life insurance policy when you face an emergency, to supplement retirement income, or when it’s part of a broader financial strategy.

What it means to cash out a life insurance policy

Cashing out of a life insurance policy means that you’re ending the contract to receive the accumulated cash value. The process involves cancelling the insurance policy. So, your beneficiaries will no longer receive the death benefit. You’ll also receive a lump sum payment to help cover your financial obligations.

You can also access the cash value of a life insurance policy without cancelling it entirely by taking out a policy loan or making a cash withdrawal.

You may choose either option if you’re experiencing a financial hardship, to supplement your retirement income, or you have unexpected expenses such as a medical bill.

Types of life insurance and whether they can be cashed out

Each type of life insurance policy has unique features and benefits. Here’s a quick overview of the three main types of life insurance, and which kind of policy allows you to access it’s cash value.

Term life insurance

Typically, there is no cash value component with term life insurance. You won’t be able to cash out a term life policy since there’s no savings or investing value. However, you may cancel your policy at any time. It’s important to note, the moment you stop paying the premiums, the coverage will end. As a result, you shouldn’t expect to receive a payout or refund.

Whole life insurance

Whole life insurance policies allows you to accumulate cash value and can be fairly straightforward to access. There are several options for cashing out this permanent life insurance policy, including:

Taking a policy loan to borrow against the cash value: There’s no credit check involved, but you’ll pay interest. Any unpaid loans and interest charges will be deducted from the death benefit.

Making a partial withdrawal: This strategy keeps the policy active, but it’ll reduce the death benefit.

Requesting a full surrender of the cash value: This option will result in the loss of insurance coverage and may lead to cancellation charges and tax implications.

We’ll explain more about these options below.

Universal life insurance

This type of permanent life insurance provides you with the most flexibility. It includes cash value that could grow over time. Similar to whole life insurance, you have the option of borrowing, withdrawing, or surrendering your policy.

Remember, depending on which option you choose, you may pay fees, reduce your death benefit, and experience tax consequences. You may also miss out on potential investment growth and lifelong protection.

Discover RBC’s permanent life insurance options, including whole life and universal life insurance. These policies provide an opportunity to build cash value and grow your financial safety net.

How cash value works

When you have a permanent life insurance policy (whole life or universal life), you may accumulate cash value through your premiums and investments. The cash value is the savings component of your insurance policy. A portion of your premiums goes towards this tax-deferred account, which you can use to withdraw or borrow from. 

For example, a whole life insurance policy allows you to build cash value over time through potential dividends and investment growth. After a decade of paying premiums, your policy should have a sizeable cash value that you may access.

5 ways to access the cash value of a life insurance policy

Here’s an overview of the different ways you can access the cash value of your life insurance policy, along with the benefits and drawbacks.

1. Surrendering the policy

When you cancel the policy, you receive access to a lump sum payment known as the cash surrender value (or CSV). This amount is your accumulated cash value less surrender fees, loans, interest or outstanding premiums. Keep in mind that you’ll lose your coverage, and part of the payout may be taxable.

2. Taking a policy loan

You may borrow against the cash value of your policy, using it as collateral. It allows you to retain the policy while accessing the funds, typically and no credit check is required. If you don’t repay the loan, the risks are that the interest accrues, and it’ll decrease the death benefit.

3. Partial withdrawals

Withdrawing a portion of the cash value maintains coverage while freeing up funds. The downside is that it permanently reduces the cash value and the death benefit that your beneficiaries receive. Also, the funds you withdraw may be subject to taxes. Unlike a policy loan, once you withdraw the funds, you can’t repay the amount into your cash value. 

4. Selling the policy (life settlement)

Certain provinces (such as Saskatchewan and Quebec) and select life insurance providers may allow you to sell your policy, known as a life settlement. You sell the policy for more than the cash surrender value but less than the death benefit. The process involves the buyer paying a lump sum, taking over the premium payments, and receiving the death benefit when the insured person passes away. However, you’ll lose your coverage, and there are potential tax liabilities.

5. Accelerated death benefits

Some insurance policies allow access to a portion of the death benefit early in cases of terminal illness. For example, with RBC’s universal life insurance, you may be eligible to receive a compassionate advance. This feature allows you to request an advance of up to 50 per cent of your policy’s death benefit (a maximum of $250,000) if you become terminally ill.

Rules and tax implications of cashing out a life insurance policy

As you evaluate your options, it’s important to understand the tax implications and to be aware of all the rules before you withdraw any funds from your insurance policy.

Here are the most common rules to know:

Taxable gains: When you cash out a policy, if the cash value is greater than the total premiums paid, then it’s deemed as taxable income. You’ll receive a T5 slip from your insurer for the taxable amount.

Surrender fees: It’s common to have surrender charges, especially in the early years if you cancel your insurance policy. These fees reduce your cash surrender value. Usually, the longer you have your policy, the lower the fees.

Policy loan interest: A loan taken out against the cash value accrues interest. You need to repay the amount you borrowed plus the interest to avoid reducing the death benefit.

Impact on beneficiaries: If you decide to cash out or borrow against a policy, it could reduce or end the death benefit that’s intended for the beneficiaries.

Comparing different life insurance policies requires you to understand the terms, conditions and the long-term implications clearly. An accredited broker can provide transparent information on fees, taxes, and other considerations. This will help give policyholders confidence when making these life-changing decisions.

Risks of accessing the cash value or cashing out a life insurance policy

When you cash out a life insurance policy, there are associated risks to be aware of:

Loss of coverage: When you surrender or sell a policy, it leaves you without life insurance protection. If you decide to get coverage at a later date, the premiums may be higher due to age or changes to your health.

Financial consequences: There’s the potential for financial instability if the cash-out amount isn’t enough to meet your long-term needs. Fees, interest on loans, and taxes may also reduce your payout or coverage.

Opportunity cost: If you choose to cash out a policy now, you’re forfeiting the future growth of the policy’s cash value along with the death benefit payout. As a result, you may miss out on long-term benefits in return for the convenient access to immediate funds.

Emotional and legacy impact: Life insurance may offer reassurance and a legacy for those who matter most to you. If you decrease or cancel your coverage, it could have an emotional toll on loved ones who will or lessen your ability to pass on an inheritance.

Alternatives to cashing out your life insurance policy

Before surrendering your life insurance policy, consider exploring other options. Here are several solutions to consider:

Adjusting the policy: It’s possible to reduce the death benefit or premium payments. Making these changes to your policy allows you to keep your policy active while still giving you financial wiggle room.

Policy loans: Instead of surrendering the policy, you may borrow against the cash value. The policy loan uses the cash value as collateral. It’s also a quick way to access your cash without any impact on your credit score. Furthermore, there’s flexibility in paying back the loan, but you’ll need to be mindful of the interest charges.

Using other assets: Look for other financial resources before tapping into your life insurance. An emergency savings fund, investment accounts such as the Tax-Free Savings Account (TFSA) or Registered Retirement Savings Plan (RRSP), or home equity line of credit (HELOC) or government benefits may be viable options.

Consulting a financial advisor: Making this decision requires thoughtful consideration, and you may need a second opinion. Consider getting expert advice from someone who can give you personalized recommendations.

Why accessing the cash value or cashing out a life insurance policy might make sense

A permanent life insurance policy may give you the option to cash out. In certain situations, cashing out could make financial sense. For instance, if you face an emergency such as medical bills or job loss, or to support you during retirement.

Bear in mind that it comes with rules, benefits, drawbacks, and financial impacts. Ensure you thoroughly review the cash-out policy, tax implications, and opportunity costs before dipping into your cash value. Consider consulting with a trusted advisor who can walk you through the possible impacts before you make any financial decisions.

Frequently Asked Questions (FAQs) about cashing out a life insurance policy

Can you cash out a life insurance policy?

Yes, if you own a permanent life insurance policy, you could cash out the policy. Whole life or universal life insurance policies gradually build cash value. However, if you have term life insurance, there’s no cash value component and you don’t have the option to cash out of this type of insurance policy.

Is cashing out life insurance taxable in Canada?

If you decide to cash out permanent life insurance, then the money you receive may be taxable. For example, if you withdraw a portion of your cash value, you’re likely to pay taxes on it. If you surrender your policy, then the cash you receive may also be taxable. In the instance of taking out a loan against your policy’s cash value, it may be subject to tax.

How much can you get if you cash out your life insurance policy?

The amount of money you receive is based on your cash value minus any unpaid premiums, interest charges, loans, or surrender fees. If you cancel your policy, the payout you receive is called the cash surrender value (CSV).

Can you cash out a policy without cancelling it?

There are several ways you can cash out a policy without cancelling it. A standard method is to access the cash value by taking out a policy loan, meaning you’re borrowing against your cash value. The coverage remains active, but any unpaid loan amount and interest will reduce the death benefit.

Another option is to make a partial withdrawal from the cash value accumulated. The policy remains in place, but it will lower the cash value, affect future growth potential, and reduce the death benefit amount.

Does cashing out affect your beneficiaries?

Yes, if you access the cash value or cash out of your life insurance policy, then it will directly affect your beneficiaries. If you cancel your policy to receive the cash value, your coverage will end. Also, your beneficiaries won’t be eligible to receive a death benefit when you pass away. If you choose to make a withdrawal or take out a policy loan, your coverage remains active. However, the withdrawal amount or loan balance will be deducted from the death benefit.

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