To keep or to cash out, that is the question

Hi y’all —

Lists of the Duggar children and the British Royal family. Instructions for how to access Netflix. Recipes for snowball cookies and buffalo chicken. Printed-out issues of Dollar Scholar, a Sam’s Club membership card and a thick stack of Arby’s coupons.

These are just a few of the items I found while going through the contents of my late grandmother’s desk. The papers she chose to keep are sweet, funny and often inexplicable, but nothing has baffled me more than the documents about the life insurance policy she’s been contributing to on my behalf for over a decade.

I have life insurance through work, and now that Oma has passed away, I need to decide whether to take over paying for that old policy or cash it out. I did a quick Google search, and it seems this isn’t an uncommon question. But everyone has a different answer.

Let’s ask the experts. Should I cash in an old life insurance policy?

Barbara Pietrangelo, chair at the life insurance nonprofit Life Happens, tells me that it’s generally possible to cash out a policy that has accumulated cash value over time. Not all life insurance policies offer this option, but permanent ones (like universal and whole life policies) tend to — so I’ll need to check what type my grandmother had to see whether cashing out is even an option.

For context, life insurance is a contract in which policyholder pays premiums to a carrier over time in exchange for payout upon a beneficiary's death. These policies usually work best for people who have lots of financial obligations or who have others relying on their income (and therefore would struggle if that income suddenly vanished).

The main perk of cashing out a life insurance policy is that I would receive a lump sum in return. Pietrangelo says this money can be helpful for emergency expenses, debt or a mortgage. (Between you and me, I’d almost definitely throw mine into my "Next Harry Styles Tour" savings bucket.)

To figure out how much that would actually be, I need to calculate the cash value. This is usually the sum of a policyholder’s contributions and compound interest, minus the surrender fees that I’ll incur when I cancel the plan.

That’s not the only math I need to do. Pietrangelo points out that there may be significant tax ramifications if I cash in my life insurance policy. Though contributions paid into a policy aren’t usually considered taxable income, gains are.

Paying taxes on what Oma put into the policy may not be worth the return on investment, she writes in an email.

Because of this, Pietrangelo says, figuring out the tax consequences should be a top priority. She recommends consulting with a tax advisor and then contacting my life insurance company to make sure I fully understand the repercussions of my decision.

This isn't an "all or nothing" choice. Jordan Skog, advanced markets director at Allianz, says I could take partial withdrawals if my carrier allows it or look into a 1035 exchange, which would let me transfer funds from one life insurance policy to another tax-free.

Speaking broadly, just because I can cash it out doesn’t mean I should. It actually might be worth playing the long game, because life insurance rates tend to go up as time goes on.

“It’s an uncommon occasion for a millennial to find greater value in surrendering a life insurance policy than in keeping one,” says Jack Dolan, spokesman for the American Council of Life Insurers.

Keeping both policies — my old one and my work one — might be a smart move. Pietrangelo says it’s not rare for people to have different types of policies with different goals in mind. For instance, a person may want a permanent policy for the long term and term policies for certain obligation-heavy periods when they’re younger (like, for instance, make sure there's enough money in the bank for tuition if my kid's in college).

Also, TBH, my work policy might not cut it.

“While employer-provided life insurance is a fabulous benefit, for many it only covers a portion of their life insurance needs,” Dolan adds.

To determine those needs and figure out whether I have quote-unquote “enough” life insurance, Pietrangelo recommends using a calculator. (Life Happens has a free one.) It’ll ask about my desired income replacement, debt, child care needs, emergency fund and more.