Should you ever encash your life insurance policy? If yes, when is the best time to do so?

Dubai: A variety of life changes or financial situations can prompt you to encash your life insurance policy. So if you’ve ever caught yourself doubting whether the life insurance policy you’re paying for is a good fit for you or you no longer feel it’s affordable or even necessary, it may be time to encash it.

“If the beneficiaries of your life insurance policy don't need the end-of-term pay-out, you may wonder if encashing your policy might be a smart decision,” said Ian Bagley, an insurance analyst based in Dubai.

“While encashing your life insurance policy may be a good idea in some cases, such as if you need the money or if the reasons for paying the premiums no longer exist, it's not something to rush into without thoughtful consideration.”

With life insurances, you make money by purchasing a policy and letting the ‘cash value’ grow over time. Then, when you retire, you can use the ‘cash value’ to supplement your income. You can also borrow against the cash value when in need of funds.

How to decide if it’s time to encash your life insurance policy?

While buying life insurance is widely considered a long-term financial commitment, if you're unable to pay the premiums or no longer need coverage, you may be able to encash your policy in what is referred to as a ‘life settlement’.

“If your policy's term is about to end, you're not likely to get any use out of it. So, encashing it allows you to recoup part of your investment,” said Anil Pillai, a UAE-based consumer banking analyst. “You can then use the proceeds from the policy sale for paying off big debts or a hefty medical bill.

"However, withdrawing from it generally reduces the policy's death benefit, so a person who wants to maximise that payment should not ideally withdraw cash value. Ultimately, deciding whether to draw cash from an insurance policy comes down to need.”

Even if your life insurance policy has become unnecessary or the premiums have become unaffordable, encashing may not be the best or only solution. Depending on the situation, there are multiple other alternatives which can better serve your needs.

What are the alternatives to encashing your life insurance policy?

“One alternative to encashing your life insurance policy is to withdraw the cash value or borrow against it, but these actions will reduce your policy’s death benefit, though, unless you repay the money. Alternatively, you can use the excess cash value to cover your premium payments,” added Bagley.

“A way to lower the cost of life insurance is to reduce the death benefit. If your policy has become unaffordable, ask your insurance agent if this is an option. The death benefit is the face value of the policy. The lower the value of your policy, the lower your insurance premiums will be.”

Pillai also suggested replacing your policy if your existing life insurance policy no longer aligns with your financial goals. “For instance, you might replace a ‘term life insurance policy’ with a ‘permanent life insurance’ to take advantage of the cash value benefits,” he explained.

“You can always surrender a life insurance policy you no longer want. In most cases, encashing your policy will net you more money than simply surrendering the policy. You can also stop making premiums payments and allow the policy to lapse, but this solution provides no cash pay-out.”

Bottom line: When is the best time to encash your life insurance policy?

A general rule of thumb, according to Bagley and Pillai, is a life insurance policy should last at least as many years as you plan to spend paying off your mortgage or credit card debt. “This can protect your loved ones from being responsible for your debts,” explained Bagley.

“In order to know if it’s time to encash your life insurance policy mainly depends on whether your beneficiaries rely on your income. If yes, consider a policy that lasts until you retire — or until you plan to have enough in savings and investments for your family to be secure without your income.”

So even though the decision to whether you should encash your life insurance policy depends on your individual financial circumstances, it is more reliant on whether your beneficiaries will suffer financially without the proceeds from your policy. So what’s the bottom line?

“If you can no longer afford to pay your life insurance premium, encashing the policy can relieve the burden of a monthly payment and will put at least some of that money back into your pocket,” added Pillai.

“Although there is always the option to simply cancel or surrender your policy to end monthly premiums, a life insurance settlement usually results in a larger pay-out and may therefore be a better option for some.”