Can I Pull Money From My Life Insurance?

Life insurance primarily provides a death benefit to beneficiaries upon the policyholder’s passing. However, certain policies also accumulate cash value, offering a source of funds during the policyholder’s lifetime. This cash value can provide financial flexibility for unexpected expenses or other needs. Not all life insurance policies include this feature.

Types of Life Insurance with Cash Value

Life insurance policies vary, with some designed solely for a death benefit and others incorporating a savings element. Cash value represents a portion of premium payments that grows over time on a tax-deferred basis. This growth is generally not taxed until it is withdrawn or the policy is surrendered.

Permanent life insurance policies are the primary types that build cash value. Whole life insurance offers guaranteed cash value growth, fixed premiums, and a guaranteed death benefit. The cash value accumulates at a predetermined rate, providing a predictable savings component.

Universal life insurance provides more flexibility, allowing adjustments to premiums and death benefits. Its cash value growth is tied to an interest rate, which can fluctuate, offering potential for higher growth than whole life. Variable universal life insurance allows policyholders to direct their cash value into various investment sub-accounts. This offers the potential for greater returns but also carries investment risk, meaning the cash value can decrease with poor market performance.

In contrast, term life insurance policies provide coverage for a specific period, such as 10 or 20 years. These policies typically do not accumulate cash value, meaning there is no savings component from which to withdraw or borrow funds. Therefore, term life insurance does not offer the option to “pull money” from the policy during the insured’s lifetime.

Methods to Access Cash Value

Policyholders with permanent life insurance have several ways to access the accumulated cash value.

One common method is taking a policy loan. This is borrowing funds from the insurer, with your policy’s cash value serving as collateral. To initiate a loan, policyholders typically contact their insurance company. Interest accrues on the loan, similar to any other debt, though there is often no strict repayment schedule.

Another way to access funds is through a cash withdrawal. This directly removes a portion of the cash value from the policy. Policyholders submit a withdrawal request to their insurer.

Finally, policy surrender involves canceling the entire life insurance policy. This process requires a formal request to the insurance provider. Upon surrendering the policy, the policyholder receives the cash surrender value, which is the cash value minus any applicable surrender charges or outstanding policy loans. Surrendering the policy terminates all coverage, including the death benefit.

Policy Implications of Accessing Funds

Accessing the cash value of a life insurance policy carries direct consequences for the policy itself.

Both policy loans and withdrawals directly reduce the eventual death benefit paid to beneficiaries. For policy loans, the outstanding loan amount, plus any accrued interest, is deducted from the death benefit when the insured passes away. With withdrawals, the death benefit is permanently reduced by the specific amount withdrawn from the cash value.

Taking loans or withdrawals can also increase the risk of the policy lapsing. If an outstanding loan balance, including accrued interest, grows to exceed the policy’s cash value, the policy can terminate. Withdrawals reduce the cash value available to cover ongoing policy charges, such as the cost of insurance and administrative fees. If the remaining cash value becomes insufficient to cover these charges and additional premiums are not paid, the policy may lapse.

Accessing funds also impacts the potential for future cash value growth. When a loan is taken, the amount borrowed typically stops earning interest or dividends within the policy, slowing down overall cash value accumulation. Withdrawals directly remove principal from the cash value, reducing the base upon which future growth can occur. Repaying policy loans can restore the full death benefit and allow the cash value to recover and resume its growth potential.

Tax Consequences of Accessing Funds

Accessing the cash value within a life insurance policy involves specific tax considerations that vary based on the method of access.

Policy loans are generally considered tax-free, as they are treated as a debt against the policy’s cash value rather than as taxable income. However, if the policy lapses or is surrendered with an outstanding loan, the loan amount, up to the policy’s “cost basis” (total premiums paid), can become taxable income. Any gains exceeding the cost basis also become taxable upon lapse or surrender.

Withdrawals from a life insurance policy are typically tax-free up to the amount of premiums paid into the policy, which is known as the “cost basis” or “investment in the contract.” Any amount withdrawn that exceeds this cost basis is considered taxable income. This taxable portion is taxed as ordinary income, not capital gains.

When a policy is surrendered, any amount received that exceeds the total premiums paid into the policy is taxable as ordinary income. Insurers may issue a Form 1099-R, “Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts,” to report taxable distributions from insurance contracts, including surrenders, withdrawals, or loans that become taxable.

A Modified Endowment Contract (MEC) presents a significant tax consideration. A policy becomes a MEC if it is funded too quickly, exceeding specific IRS limits known as the “7-pay test.” For MECs, loans and withdrawals are subject to “last-in, first-out” (LIFO) taxation, meaning earnings are considered to be distributed first and are immediately taxable as ordinary income. If these taxable distributions from a MEC occur before the policyholder reaches age 59½, they may also be subject to an additional 10% federal penalty tax, similar to early withdrawals from retirement accounts. Once a policy becomes a MEC, this classification is permanent.