With the rising costs of essential aspects of living, such as health care and housing, your parents may be considering alternate ways of ensuring the stability of their financial future. One such way may be cashing in their life insurance policies. However, this decision comes with risks and benefits.

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Do all life insurance policies have cash value?

No, not all types of life insurance provide the option of cashing out. If your parents invested in a term life insurance policy, then they’re pretty much out of luck. Permanent life insurance policies, such as whole life insurance and universal life insurance, will include an option to cash out, though. When checking the details of a policy, look for the surrender value. This is the amount the policyholder would receive (minus any fees).

Reasons to consider cashing in a life insurance policy

Now, let’s consider some of the best reasons for going ahead with cashing in a life insurance policy while the insured is still alive. For a lot of people who consider this option, the trigger will be something like increasing health care costs or a dip in the value of their stocks. Many seniors fail to account for the full cost of medical expenses in their retirement years. Even those who plan and invest carefully may be caught off guard by changes in financial markets and the economy.

If your aging loved ones need help covering retirement living expenses, health care expenses, or long-term care costs, then it may be smarter to cash out their life insurance policy rather than continue paying premiums. A withdrawal or partial cash surrender may also let your parents access some of the cash value of their policy but without cancelling their coverage.

Reasons not to cash in a life insurance policy

On the other hand, there are some pretty compelling reasons to hold off on this decision. First, think about how the rest of the family might be affected. If Dad passes away and Mom doesn’t receive the payout from the life insurance policy, will she still be financially secure?

If your parents currently have unpaid debts, then Dad’s estate may take a hit and Mom may need to rely on the death benefit from the life insurance policy to make ends meet. Unlike other assets that must go through the probate process, death benefits are typically paid directly to the beneficiary named in a life insurance policy.

Don’t forget to consider taxes and surrender fees, too. For example, cashing in a newer policy will likely incur surrender fees for pulling out money so early. If your parents only take out part of the total available cash in a policy, then they may not have to worry about taxes. But if they cash in the whole thing or take out more than the amount they’ve paid in, then they’ll be taxed on the gains.

Alternatives to cashing in a life insurance policy

Cashing in a life insurance policy in isn’t the only option if your parents need cash now.

Exchange it

Many life insurance policies provide the option of exchanging the original policy for a new insurance or annuity contract without having to pay income tax on the investment gains. This isn’t the right approach for every family, so carefully weigh the pros and cons before acting on it.

Take out a loan

Another option is borrowing against the cash value of a life insurance policy. This approach works best with older policies that have built a larger cash value over time and in situations where the policyholder is able to pay the loan back. As with all loans, there are interest charges and there may be tax consequences.

Sell it

Finally, your parents can sell a whole life policy to a third party. With this kind of arrangement, the policyholder gets a set amount of cash in exchange for the policy, the buyer commits to continuing to pay the premiums, and they’re the ones who receive the death benefit when the insured dies.

Depending on the current status of your parents’ finances and their unique needs, it may be worth taking advantage of one of the options above. However, it’s best to discuss all options with a reputable financial advisor before taking action.

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Kristen Hicks

The information contained in this article is for informational purposes only and is not intended to constitute medical, legal or financial advice or create a professional relationship between A Place for Mom (of which OurParents is a trademark) and the reader. Always seek the advice of your health care provider, attorney or financial advisor with respect to any particular matter and do not act or refrain from acting on the basis of anything you have read on this site. Links to third-party websites are only for the convenience of the reader; A Place for Mom does not recommend or endorse the contents of the third-party sites.

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