Can I Get Money From My Life Insurance?

Life insurance policies are designed to provide financial protection to beneficiaries after the insured’s passing. However, a common question arises for many policyholders: can funds be accessed from a life insurance policy during their lifetime?

The answer depends significantly on the type of policy held, as some forms of life insurance accumulate a value that can be accessed under certain conditions. Understanding these possibilities is important for policyholders seeking to leverage their insurance assets. This ability to access funds can transform a policy from solely a death benefit tool into a more flexible financial instrument.

Life Insurance and Cash Value

Life insurance policies typically fall into two main categories: term life insurance and permanent life insurance. Term life insurance provides coverage for a specific period and does not accumulate any cash value. This means it offers a death benefit only, and once the term expires, the coverage ends, and there are no residual funds to access.

In contrast, permanent life insurance, such as whole life or universal life policies, includes a savings component known as cash value. This cash value is a portion of the premium payments that accumulates over time on a tax-deferred basis, separate from the policy’s death benefit. As premiums are paid, a part is allocated to cover the cost of insurance and administrative fees, while the remainder contributes to this growing cash value component.

The cash value grows through guaranteed interest rates or investment performance, depending on the specific policy type. While a policy’s cash value may take a few years to begin accumulating significantly, typically 2 to 5 years, it can become a substantial asset over decades. This accumulated cash value can serve as a financial resource for the policyholder during their lifetime.

Methods for Accessing Policy Funds

Policyholders with permanent life insurance often have several avenues to access the accumulated cash value within their policies. These methods allow individuals to utilize their policy’s value while still alive, though each comes with its own mechanics and implications.

Policy Loans

One common method is taking a policy loan, where the policyholder borrows money from the insurer, using the policy’s cash value as collateral. Unlike traditional loans, these do not require credit checks or a lengthy approval process, as the loan is secured by the policy’s own value. Interest accrues on the loan balance, often at a rate set by the insurer, which can be variable or fixed. While repayment schedules are flexible and often not mandatory, any outstanding loan balance, including accrued interest, will reduce the death benefit paid to beneficiaries.

Cash Withdrawals

Another way to access funds is through cash withdrawals from the policy’s cash value. When a withdrawal is made, it directly reduces both the policy’s cash value and the death benefit. Unlike loans, withdrawals are permanent reductions to the policy’s value and are not expected to be repaid.

Policy Surrender

A more drastic measure is policy surrender, which involves terminating the life insurance coverage entirely in exchange for the policy’s cash surrender value. The cash surrender value is the accumulated cash value minus any applicable surrender charges or outstanding loans. Electing to surrender a policy means giving up the death benefit, which will no longer be available to beneficiaries.

Accelerated Death Benefits

Some policies include provisions for accelerated death benefits, also known as living benefits. These allow policyholders to access a portion of their death benefit while still alive, typically under specific qualifying circumstances. Common triggers include a diagnosis of a terminal illness with a limited life expectancy, or a chronic illness requiring long-term care.

Life Settlements

A life settlement involves selling a permanent life insurance policy to a third-party buyer for a lump sum. This amount is typically greater than the policy’s cash surrender value but less than the full death benefit. The buyer takes over premium payments and becomes the new owner and beneficiary of the policy, receiving the death benefit upon the insured’s passing.

Financial and Tax Considerations

Accessing funds from a life insurance policy carries various financial and tax implications that policyholders should carefully consider. The way funds are accessed dictates the potential tax consequences and the impact on the policy’s future.

Policy Loans

Policy loans are generally not considered taxable income, as they are viewed by the IRS as a debt against the policy’s value, not a distribution of earnings. However, if the policy lapses or is surrendered with an outstanding loan, the loan amount exceeding the cost basis (total premiums paid) can become taxable as ordinary income. Interest on policy loans is typically not tax-deductible.

Cash Withdrawals

Cash withdrawals are generally tax-free up to the policy’s cost basis. The cost basis represents the total amount of premiums paid into the policy. Any amount withdrawn that exceeds this cost basis is typically considered taxable income and is taxed at ordinary income rates. For policies classified as Modified Endowment Contracts (MECs), withdrawals are taxed on a “last-in, first-out” (LIFO) basis, meaning earnings are taxed first, and a 10% penalty may apply if the policyholder is under age 59½.

Policy Surrender

When a policy is surrendered, any amount received that exceeds the total premiums paid (cost basis) is considered taxable gain and is taxed as ordinary income. Surrender charges, which can be significant, especially in the early years of a policy, will also reduce the payout.

Accelerated Death Benefits

Accelerated death benefits are generally tax-exempt under federal law if the insured meets specific criteria for terminal or chronic illness, as outlined by HIPAA guidelines. For a terminal illness, this typically means a life expectancy of 24 months or less. For chronic illness, the benefits must be used for qualified long-term care expenses, and any amount exceeding certain IRS per diem limits, such as $420 per day in 2024, could be taxable. If the medical condition does not meet the IRS definition, the benefits may become taxable.

Life Settlements

Life settlements have a more complex tax treatment, typically involving a three-tiered approach. The portion of the proceeds up to the policyholder’s cost basis is generally tax-free. The amount received between the cost basis and the policy’s cash surrender value is taxed as ordinary income. Any proceeds received above the cash surrender value are taxed as capital gains.