Can I Cash Out My Universal Life Insurance Policy?

Universal Life (UL) insurance is a type of permanent life insurance that offers both a death benefit and a savings component, known as cash value. This cash value grows over time, providing policyholders with a financial resource accessible during their lifetime. This article explores the mechanics of universal life policy cash value and the methods available to access it.

Understanding Universal Life Policy Cash Value

The cash value within a Universal Life policy represents a savings component that accumulates over the life of the policy. When you make premium payments, a portion covers the cost of insurance, including mortality charges and administrative fees, while the remainder is allocated to this cash value account. This allocated amount then earns interest, contributing to its growth on a tax-deferred basis.

The growth of this cash value is influenced by several factors, including the interest rates credited by the insurer, which can be fixed or linked to a market index for Indexed Universal Life (IUL) policies. Policy expenses, such as premium loads (typically 5-10% of each payment), administrative fees (often $5-$15 monthly), and the cost of insurance (COI), also impact the net accumulation. As the policyholder ages, the COI generally increases, which can affect the cash value’s growth trajectory if not offset by sufficient premium payments or interest earnings. The death benefit is paid to beneficiaries upon the insured’s passing, while the cash value is a living benefit accessible to the policyholder.

Ways to Access Your Universal Life Policy Value

Policyholders have several methods to access the accumulated cash value within their Universal Life policy. One common approach is taking a policy loan, where the cash value serves as collateral for the borrowed amount. The policy remains in force, and interest accrues on the loan. Repayment is flexible, and outstanding loan balances typically reduce the death benefit.

Another method is a partial withdrawal, which directly reduces the policy’s cash value and the death benefit. Unlike a loan, a withdrawal removes funds permanently from the policy and does not require repayment.

Finally, policy surrender involves terminating the entire insurance contract for the policy’s net cash surrender value. This action ends the life insurance coverage. The amount received is the cash value less any applicable surrender charges and outstanding loans.

Financial and Tax Considerations

Accessing your Universal Life policy’s cash value involves important financial and tax considerations that can significantly impact the net amount received. When surrendering a policy, insurance companies often impose surrender charges, which are fees deducted from the cash value. These charges typically decline over a period, often 10 to 15 years, and are highest in the early years of the policy.

Policy loans are generally tax-free as long as the policy remains in force. However, if the policy lapses or is surrendered with an outstanding loan, the loan amount can become taxable if it exceeds the policy’s cost basis. The cost basis is generally the total premiums paid less any prior tax-free withdrawals. This can create an unexpected tax liability.

Partial withdrawals are typically treated under the “first-in, first-out” (FIFO) rule for tax purposes. Withdrawals are considered a return of your premium payments (cost basis) first, which is tax-free. Once total withdrawals exceed your cost basis, any subsequent amounts are considered taxable gains and are taxed as ordinary income.

Upon policy surrender, the taxable gain is calculated as the cash surrender value received minus your cost basis. Only this gain portion is subject to ordinary income tax.

A policy can also become a Modified Endowment Contract (MEC) if it fails the “7-pay test,” which limits the amount of premium that can be paid into a policy during its first seven years. If a policy becomes a MEC, the tax rules for loans and withdrawals change significantly. Distributions from a MEC are taxed on a “last-in, first-out” (LIFO) basis, meaning earnings are considered to be distributed first and are taxable as ordinary income. Additionally, distributions from a MEC before age 59½ may be subject to a 10% federal income tax penalty, similar to withdrawals from qualified retirement plans.

The Policy Surrender Process

Surrendering a Universal Life insurance policy to access its cash value involves a procedural sequence. The first step is to contact your insurance provider. This can typically be done by calling their customer service line, accessing their online policyholder portal, or reaching out to your insurance agent.

Once contact is made, the insurer will guide you through the necessary documentation. You will generally be required to complete a specific surrender form, provide proof of identity, and submit the original policy document.

After gathering the necessary forms and documents, you will need to submit them to the insurance company. Common submission methods include mailing the documents to their designated processing center, uploading them securely through an online portal, or, in some cases, submitting them in person at a local office. Following submission, the processing time can vary, but policyholders can generally expect the process to take anywhere from a few days to several weeks. Upon completion, the insurer will typically send a final statement detailing the transaction and disburse the net cash surrender value to you via check or electronic funds transfer.