Can I Get Money From My Life Insurance Policy?

Life insurance policies are primarily designed to provide financial security to beneficiaries after the policyholder’s passing. However, certain types of policies also offer the ability to access funds during the policyholder’s lifetime. This can be a significant financial resource, providing liquidity for various needs. Understanding the different avenues for accessing this money and their implications is important for policyholders.

Understanding Cash Value in Life Insurance

Cash value refers to a savings component within specific types of permanent life insurance policies. A portion of each premium payment contributes to this account, which grows over time on a tax-deferred basis. This accumulation provides a living benefit accessible by the policyholder.

Policies that build cash value include Whole Life, Universal Life, and Variable Universal Life insurance. Whole Life policies offer a guaranteed growth rate. Universal Life policies provide flexibility in premiums and death benefits, with growth tied to an insurer-set interest rate. Variable Universal Life policies allow policyholders to invest the cash value in various sub-accounts, with growth dependent on investment performance.

In contrast, term life insurance policies do not build cash value. These policies provide coverage for a specific period and typically offer a lower premium than permanent policies, as they lack a savings component.

Accessing Funds Through Policy Loans

One common method to access funds is by taking a loan against the policy’s cash value. A policy loan is not a withdrawal; it is money borrowed from the insurer, with the cash value serving as collateral. The policy remains in force while the loan is outstanding, and the cash value continues to grow.

Policy loans accrue interest, which can be fixed or variable, typically ranging from 5% to 8% annually. This interest can be paid regularly or added to the outstanding loan balance, increasing the total amount owed. While repayment is not required, any outstanding loan balance, including accrued interest, will reduce the death benefit paid to beneficiaries.

If the loan balance, including unpaid interest, exceeds the policy’s cash value, the policy can lapse. This terminates coverage and may trigger an unexpected tax liability on the policy’s gain. Policy loans are generally not considered taxable income as long as the policy remains in force and the loan amount does not exceed premiums paid.

Accessing Funds Through Withdrawals and Surrenders

Policyholders can access funds directly from their cash value through partial withdrawals or by surrendering the entire policy. A partial withdrawal takes money directly from the cash value, reducing it and potentially decreasing the death benefit. The portion representing a return of premiums paid (cost basis) is generally tax-free. However, any amount withdrawn exceeding this cost basis is typically taxable as ordinary income.

A full policy surrender involves terminating the life insurance policy entirely. The policyholder receives the “cash surrender value,” which is the cash value minus any applicable surrender charges and outstanding loans. Surrender charges are fees imposed by the insurer, especially in early years, and usually diminish over 10 to 15 years.

Surrendering a policy means losing all life insurance coverage, including the death benefit. Any amount received from a surrender exceeding total premiums paid is considered taxable income. While surrendering provides immediate access to a lump sum, it costs future coverage and can have tax implications.

Accessing Funds Through Alternative Options

Beyond direct loans or withdrawals, other avenues exist for accessing money from a life insurance policy. Accelerated Death Benefits (ADBs) allow policyholders to access a portion of their death benefit while still alive, typically under specific qualifying circumstances. These often include a terminal illness with limited life expectancy, a chronic illness preventing daily living activities, or a critical illness like a heart attack or stroke. The amount received through an ADB reduces the eventual death benefit paid to beneficiaries.

Another alternative is a life settlement, which involves selling an existing life insurance policy to a third-party company. In a life settlement, the policyholder receives a lump sum greater than the cash surrender value but less than the full death benefit. The buyer takes over responsibility for paying future premiums and becomes the new beneficiary, receiving the death benefit upon the insured’s death. Life settlements are often considered by older individuals or those with declining health who no longer need or can afford their policies.

Important Considerations for Accessing Funds

Accessing funds from a life insurance policy carries several financial and policy consequences. Tax implications are a significant factor; policy loans are generally tax-free unless the policy lapses with an outstanding loan exceeding the cost basis. Withdrawals beyond the cost basis can be taxable as ordinary income. Similarly, gain from a policy surrender is taxable, and life settlement proceeds have a tiered tax structure, with portions potentially taxed as ordinary income or capital gains. Accelerated Death Benefits are usually tax-exempt if specific IRS conditions for terminal or chronic illness are met.

A common consequence across all methods is a reduction in the death benefit paid to beneficiaries. Whether through a loan, withdrawal, or accelerated payout, the amount available for beneficiaries will be less than the original face value. This impacts the financial security planned for loved ones.

Accessing funds can also increase the risk of the policy lapsing. Outstanding policy loans erode cash value, and withdrawals directly reduce it, potentially leaving insufficient funds to cover ongoing policy charges. If the cash value can no longer sustain the policy and additional premiums are not paid, the policy may terminate, leading to a loss of coverage and potential tax liabilities on outstanding loans or gains. This may also require higher out-of-pocket premium payments to maintain its in-force status.