Does It Make Sense to Cash In Your Whole Life Insurance Policy Early?

Monday, May 18, 2015

surrendering-policy-earlyIt’s often suggested that borrowing against the cash value of your whole life insurance is a bad idea. More often than not, this is the case -but there are exceptions. Depending on your individual circumstances, borrowing against your life insurance cash value is not necessarily a bad thing.

A whole life (or permanent life) insurance policy requires that the policyholder pay premiums throughout his or her lifetime. Over time, a whole life insurance policy builds cash value, which can be paid out to the policyholder at a certain point. Upon the policyholder’s death, a lump sum will be paid to any surviving beneficiaries.

 

Why you might want to surrender your policy early

Sometimes, whole life insurance holders make the decision to cash in or surrender their policies early. Here are some of the most common reasons why:

  • High premiums: Whole life insurance premiums are higher than premiums for term life insurance. Many whole life insurance holders find it difficult to make these payments in later years. This is a common reason for choosing to cash in a life insurance policy early.
  • Tax-free withdrawals: An upside of borrowing against the cash value of your life insurance policy is that withdrawals are tax-free - as long as they don’t exceed the amount of the premiums you have paid. However, any outstanding balance at the time of your death becomes taxable.
  • Bad credit: Sometimes, conventional loans just aren’t an option. Policyholders who are strapped for cash and have poor credit scores may make the decision to borrow against their life insurance cash value.

Things to keep in mind before you cash in

Before you cash in your life insurance policy early, it’s important to understand the consequences. Here are a few ramifications you should be aware of:

  • There’s no such thing as “free” money: Many people think that borrowing money from a policy comes with no strings attached. Unfortunately, this is not the case. Each time you make a withdrawal from your life insurance, your insurance company charges interest.
  • You don’t have to repay the loan, but the interest continues to build: Unlike a bank loan, you don’t have to pay it back, and chances are you never will. But the interest on the borrowed amount will continue to grow, eating away at any payouts due your loved ones when you pass away.
  • Your loved ones will pay: If you cash out your life insurance policy early or borrow against it, the amount of the death benefit is reduced. That means that your beneficiaries will have less money or none at all upon your death.

Clearly, cashing in your life insurance policy early is not a decision to be made in haste. Despite any financial difficulties you may currently be facing, it’s important to weigh the long-term consequences against the short-term benefits of surrendering your policy.

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