Cashing in or surrendering a life insurance policy typically has tax implications. When you surrender a policy, the amount received over and above the premiums paid is considered taxable income, similar to wages. However, loans taken against the policy’s cash value are not taxable as long as the policy remains in force.

Selling a life insurance policy in the form of a viatical settlement—where the policyholder has a serious medical condition and sells the policy for immediate cash—is not considered taxable income. It is necessary to consult with a financial advisor to understand the specific tax rules and potential liabilities involved in cashing in or selling a life insurance policy, as these actions can greatly impact your financial situation and tax responsibilities.

Blog feature image with a pen and a paper with american life fund agents in the background and a caption that says cashing in life insurance

Types Of Life Insurance Policies

Numerous life insurance policies are available so that you can tailor the coverage to your specific needs and life stage.

Whole Life Insurance

Whole life insurance is the most comprehensive type. It provides a death benefit for your beneficiaries and cash value that you can use if needed.

Term Life Insurance

Term life insurance is more affordable and offers protection for a specific period, such as 10 or 20 years.

Universal Life Insurance

Universal life insurance combines whole and term life elements — offering a death benefit with flexible premiums, coverage amounts, and payment schedules.

Variable Universal Life Insurance

Variable universal life insurance provides the flexibility of universal life. It allows policyholders to invest in market-based investments within the policy.

Is Cashing in Life Insurance Taxable?

Most life insurance policies offer cash out options when policyholders surrender their policy to the carrier. This withdrawal is taxed as normal income, subjecting it to similar taxation rules as wages and other earned income. It’s important to understand the tax implications of a life insurance cash out, so you can be sure to make an informed decision.

Is The Sale Of A Life Insurance Policy Taxable?

Selling a life insurance policy could be a good option if you’re faced with urgent financial obligations. It is important to note that any money made from the sale of the policy is considered taxable income, unless it’s a viatical settlement.

A viatical settlement is a legal agreement that allows a life insurance policyholder with a serious medical condition to exchange their life insurance policy for an immediate cash payout. The beneficiary of the policy, generally referred to as the “Viator”, will become the new policy owner.

To understand tax liabilities, speaking with a financial planner or professional who manages taxes and finances can be beneficial. Doing so could save you from a surprise come tax season!

is cash value on life insurance taxable

How To Withdrawal From A Life Insurance Policy Without Tax Implications

If you’re looking to withdraw from your life insurance policy without facing tax implications, the best way is to borrow or withdraw from the policy’s cash value, our sell your policy through a viatical settlement. This money will be tax-free as long as it is used for premiums or other specified expenses. Most whole and universal life insurance policies come with a “cash surrender” option that allows you to take out a loan against the funds in the account.

Remember, each situation is different, so talk to your life insurance provider or financial advisor about the best way to withdraw from your policy without facing tax implications.

Taking A Loan From Your Life Insurance Policy

Taking a loan from your life insurance policy is another great way to withdraw money without paying taxes. You can use the money for whatever you need. Most insurers offer these types of loans at reasonable interest rates.

One thing to note about borrowing from your life insurance policy is that if you don’t repay the loan, the total death benefit will be reduced by the amount you borrowed. So, it’s important to think carefully before taking out a loan and make sure you can afford to repay it.

What Happens When You Surrender A Whole Life Policy?

When you surrender a whole life policy, the insurance company will cash out the cash value of the policy minus any fees, taxes, or other charges. If there is not enough cash value to cover these expenses, you may be responsible for paying them yourself. In addition, if you have previously taken out loans against your policy, these must also be repaid.

Once the policy is surrendered, you will no longer have any coverage and will not receive a death benefit. Also, depending on your state, you may be subject to surrender charges or other penalties if you are younger than the designated age limit (usually around 65).

Overall, it is important to consider the implications of surrendering your whole life policy before doing so. Although it may provide immediate cash, the drawbacks should be considered.

tax on surrender of life insurance policy

What Happens When You Withdraw A Portion Of The Cash Value Of A Life Insurance Policy?

When you withdraw a portion of the cash value from your life insurance policy, this is like taking out a policy loan. The money will be paid to you directly and will not be subject to taxes (unless the policy was funded with pre-tax dollars). However, it is important to note that if you do not repay the loan, you could face a tax penalty or be required to surrender the policy. Additionally, if you withdraw more money than the cash value of your policy, you may also be subject to additional fees.

How Can I Avoid Paying Capital Gains Tax?

The best way to avoid paying capital gains tax on life insurance cash outs is to ensure that all policies are properly funded with already taxed income and transferred into irrevocable trusts before death occurs.

Consulting with a knowledgeable financial advisor can help ensure that all policies meet IRS requirements. Advisors can also provide additional guidance on other options for avoiding taxes on life insurance cash outs.

Turn Your Life Insurance Policy Into Cash Through A Viatical Settlement

At American Life Fund, we specialize in helping policyholders turn their life insurance policies into cash through our viatical settlement program. Viatical settlements allow someone diagnosed with a life-threatening illness to sell their life insurance policy for cash. This person is known as the “Viator.”

The third party they sell their policy to is an institutional investor, usually a viatical settlement company such as us here at American Life Fund. When selling a policy in a viatical settlement, the policyholder sells it for more than the surrender value but less than the total death benefit.

When you receive the funds, they’re yours. There are no strings attached and no limits on usage – whether you want to buy a house, a car, or a piece of art or pay off debts for yourself or your family. Viatical settlements are not treated as part of your income, so the lump sum payment you receive for selling your policy will not be taxed.

Key Takeaways

  • When withdrawing from your life insurance policy, borrowing or withdrawing from the policy’s cash value is the best way to avoid taxes.
  • Taking a loan from your life insurance policy can effectively access money without paying any taxes.
  • Surrendering a whole-life policy will mean you forfeit all coverage and any associated death benefits.
  • When taking out a loan against your policy, you must make sure you can repay it to avoid reducing the policy’s death benefit.

In Conclusion

When deciding how to access money from your life insurance policy, it is important to consider all of the implications and make sure that any withdrawal or loan does not impact the death benefit associated with the policy.

Consulting a knowledgeable financial advisor can help ensure all policies comply with IRS regulations and provide additional guidance on other options for avoiding taxes when cashing out life insurance. By being aware of the different ways to access money from your policy, you can make the most of it and ensure that it provides optimal protection and financial security for your family.

If you want to see how much you can get for your policy with a viatical settlement, complete our simple form for your instant offer estimate!

About the Author: Eugene Houchins

In 2005, Gene Houchins founded American Life Fund, addressing a significant gap in financial options for life insurance policyholders. As its leader, Gene specializes in providing swift financial support for those with severe illnesses. Through viatical settlements, his organization is able to assist patients with funding medical and living expenses through their existing life insurance policies.

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