Life often presents unexpected financial challenges, like sudden medical bills, mounting debts, essential home repairs, or everyday living expenses. In times of such unforeseen circumstances, you may wonder if it’s possible to cash out your life insurance policy.
Cashing out your life insurance policy can be a lifeline when you urgently require funds. Permanent life insurance policies have a cash value feature that grows over time. This cash value can be accessed through policy loans, withdrawals, or partial or total surrender.
However, it’s crucial to understand that while cashing out your life insurance policy can be helpful and necessary in tough financial times, there are potential unwanted consequences associated with accessing these funds.
In this article, we will delve into how cashing out your life insurance policy works, when and how to use it wisely and explore alternative options you may want to consider when you need funds.
Can You Cash Out Your Life Insurance Policy in Canada?
Can You Cash Out Your Life Insurance Policy in Canada? Yes, you can indeed cash out your life insurance policy in Canada.
Cash-value insurance policies, such as whole or universal life insurance, come with a unique feature: a cash accumulation component built right into the insurance policy. This component is designed to hold excess premiums and earnings.
During financial uncertainty, when you require cash for yourself or your family, you can cash out from the accumulated cash value within your policy. This cash value of a life insurance policy represents the monetary worth that your policy has gathered since its inception.
However, knowing that cashing out your life insurance policy can have tax implications is important. There are various methods available for accessing the cash value of your insurance policy, each with its own set of advantages and disadvantages.
How to Cash Out Your Life Insurance Policy
If you’re considering cashing out your life insurance policy in Canada, it’s crucial to understand the five different methods available, each with its tax implications.
However, to make an informed decision about which option suits you best, it’s advisable to consult with an insurance professional. They can provide valuable guidance tailored to your specific circumstances.
1. Cash Value Withdrawals
If you need cash, your insurance policy may allow you to access the cash value it has accrued over time. Some insurance companies may even require you to utilise this cash value during your lifetime; otherwise, you risk losing it.
You can withdraw any amount from your insurance policy up to its total cash value. However, it’s important to note that because these withdrawals are not intended to be repaid, they deplete the policy’s cash value. This depletion can significantly impact the eventual death benefit payout your beneficiaries will receive upon passing.
Additionally, it’s worth mentioning that if the amount you withdraw surpasses the Adjusted Cost Base (ACB), you may be subject to taxation on the excess withdrawal.
2. Policy Loans
If you need temporary cash and intend to repay, you can tap into the cash value of your life insurance policy through a policy loan. The key distinction between this option and the first one is your commitment to repayment.
The advantage of this approach is that you’re essentially borrowing from your own funds, which comes with some enticing benefits such as low interest rates, flexible repayment terms, and no obligatory monthly payments.
However, it’s crucial to adhere to your loan repayment schedule diligently. Failure to do so can have consequences, primarily affecting your policy’s death benefit. If you cannot fully repay your loans before passing, your family will receive a reduced payout, as the loan amount and accumulated interest will be deducted.
Furthermore, there’s a risk of your insurance policy lapsing if you fail to meet your repayment obligations promptly. Over time, the interest on your loan can accumulate to the point where it exceeds your policy’s cash value, resulting in a policy lapse.
It’s important to note that if your loan amount surpasses your insurance policy’s Adjusted Cost Base (ACB), the excess loan amount becomes taxable.
3. Collateral Loans
Another method to access funds from your life insurance policy involves approaching a financial institution or credit union and applying for a loan, using the cash value of your life insurance policy as collateral security.
By leveraging your policy’s cash value as collateral, the loan you receive will be repaid to the lender from your death benefit if you pass away without fully repaying the loan.
One potential advantage of using your policy’s cash value as collateral is that it may result in more favourable loan interest rates. However, it’s important to note that if you fail to repay the loan fully, your beneficiaries will ultimately receive a reduced payout.
Typically, financial institutions are willing to lend you approximately 75-90% of your policy’s cash value. These loans can be repaid at your convenience, and whether or not the interest is subject to taxation may depend on the purpose for which you use the borrowed funds.
4. Opt for Partial or Full Surrender
If you find yourself in a situation where your life insurance coverage is no longer necessary, or you’re tired of keeping up with premium payments, you can surrender your policy and receive its cash value.
The Cash Surrender Value (CSV) represents the sum of your accumulated cash value, but it may be subject to deductions in the form of surrender charges or fees imposed by the insurer. You can exercise this option to cancel your insurance at any time, and in return, you’ll be provided with your CSV.
It’s important to note that surrendering your policy in the initial few years is generally not advisable due to high surrender fees during this period. These fees can significantly erode a substantial portion of your cash value. If you still intend to receive some money after accounting for the surrender fee, make sure to clear any outstanding loans and associated interests before proceeding with the surrender.
Remember that your Cash Surrender Value will be subject to taxation, but this tax obligation typically applies only to the interest earned on your premiums.
5. Life Settlements
You can also cash out your life insurance policy by selling your insurance policy to a third party in exchange for a single lump-sum payment.
It’s important to note that in Canada, most provinces do not permit the sale of insurance policies. However, there are exceptions, and the provinces of Quebec, New Brunswick, Nova Scotia, and Saskatchewan do allow such transactions.
Furthermore, it’s crucial to be aware that certain insurance companies in Canada have policies prohibiting the sale of their insurance policies. To navigate this, you should contact your insurer and inquire about their stance on selling life insurance policies.
When to Consider Cashing Out Your Life Insurance
Everyone buys life insurance to provide a lifetime of financial protection for themselves and their loved ones. However, certain situations will make you consider cashing out your life insurance policy.
Here are a few.
- You no longer need coverage because your beneficiaries have passed away or don’t rely on your financial support
- You are in debt, and you need the cash to get out of your debt
- You want to reduce your premiums, so you take out a loan to pay premiums or surrender the policy.
- You have large financial responsibilities like buying a new home, funding your child’s education, etc.
- You found a better insurance provider with better options
- You have a poor credit score and need cash immediately
Alternatives to Cashing Out Your Life Insurance Policy
If you are in urgent need of cash and contemplating cashing out your life insurance policy, it’s worth exploring alternative options before making a decision.
One viable alternative is applying for a personal loan from financial institutions, credit unions, or personal lenders. They can offer you the immediate cash you require, typically at reasonable interest rates.
Before taking any action, it’s advisable to consult with your financial advisor. They can help you assess your situation and guide you in choosing the best alternative to meet your financial needs, allowing you to make an informed choice rather than prematurely cashing out your insurance policy.
Final Thoughts on Cashing Out Your Life Insurance Policy In Canada
Life insurance is primarily designed to provide financial support to your loved ones in the event of your passing. However, it’s worth noting that you can also cash out your life insurance while alive. The options mentioned above provide avenues for accessing the cash value of your life insurance policy when you require immediate funds.
Cashing out your life insurance policy can be a valuable resource when you urgently need money. However, the choice of option depends on the amount of money you require and whether you wish to retain your coverage.
FAQs on Cashing Out Your Life Insurance Policy In Canada
How do I find the cash value of my life insurance policy?
Contact your insurer, and they will pay you whatever cash value your policy has accumulated. The net cash value is the actual surrender value of the policy. The net cash value is listed separately in your life insurance statements.
How to withdraw money from life insurance policy
You can withdraw money from your life insurance policy by withdrawing from your accumulated cash value. It’s your money, and you can withdraw from it.
What are the tax consequences of cashing in a life insurance policy?
If you choose to cash out your life insurance policy, you will pay taxes on the interests the policy has made over time. Any amount that exceeds the investments (premiums) you paid will be taxed.
How long does it take to cash out life insurance policy?
It is advisable to leave your insurance policy for the first 10-15 years before you tap into the cash value. This will give the cash value enough time to grow, and the surrender fees will be lesser at this time. Generally, it takes 14-60 days to process your cash-out request when you apply.
