Can I Take Money From a Life Insurance Policy?

Life insurance policies serve as a financial safety net for beneficiaries, providing a death benefit upon the policyholder’s passing. However, certain types of policies also offer avenues for policyholders to access funds during their lifetime. This capacity to tap into a policy’s value can be a valuable financial resource, enabling individuals to address various financial needs that arise before the death benefit is paid out. Understanding these mechanisms allows policyholders to leverage their life insurance assets beyond their primary purpose.

Understanding Policy Loans

Policy loans primarily apply to permanent life insurance policies, such as whole life or universal life, which build cash value over time. A policy loan is essentially borrowing money from the insurer, using the accumulated cash value within the policy as collateral. The funds for the loan do not come directly from the policy’s cash value; instead, the cash value serves as a guarantee for the insurer.

Interest accrues on these loans, with rates typically ranging from 5% to 8%. While there isn’t a strict repayment schedule, interest must be paid annually, and if not, it is added to the loan amount. Policy loans are generally tax-free, provided the policy remains in force and the loan amount does not exceed the premiums paid. However, if the policy lapses or is surrendered with an outstanding loan, the borrowed amount, particularly any gains, can become taxable income.

To apply for a policy loan, the policyholder contacts their insurance company to request a loan application form. This form requires basic information such as the desired loan amount, policy number, and banking details for direct deposit. The processing time for these loans is often quick, with funds potentially disbursed within a few days, as no credit check or extensive approval process is involved. The policy continues to provide coverage as long as premiums are paid and the loan balance, including accrued interest, does not exceed the cash value, though an outstanding loan will reduce the death benefit paid to beneficiaries.

Making Cash Value Withdrawals

Direct withdrawals from the cash value of a permanent life insurance policy offer another way to access funds. Unlike a loan, a withdrawal permanently removes money from the policy and does not need to be repaid. This action directly reduces the policy’s cash value and, consequently, the death benefit paid to beneficiaries.

Tax implications for withdrawals depend on the amount relative to the policy’s “cost basis,” which is the total premiums paid into the policy. Withdrawals are typically tax-free up to this cost basis. Any amount withdrawn exceeding the cost basis is considered taxable income and is taxed at ordinary income rates, not capital gains.

The process for requesting a withdrawal involves contacting the insurance provider and completing a withdrawal request form. This form requires specific details, including the amount to be withdrawn and banking information for direct deposit. After submission, the insurer processes the request, and the policyholder receives confirmation of the reduced policy value.

Cashing Out Your Policy

Surrendering a life insurance policy means terminating the coverage entirely in exchange for its accumulated cash surrender value. This action provides a lump sum of money but permanently ends the insurance coverage, meaning no death benefit will be paid to beneficiaries.

Surrender charges may apply, particularly if the policy is terminated early in its life, which can significantly reduce the amount received. Tax implications arise if the cash surrender value received exceeds the policy’s cost basis. This excess is considered a taxable gain and is taxed as ordinary income.

To surrender a policy, the policyholder must formally notify the insurance company by completing a surrender request form. This form requires identification verification and banking details. The insurer then calculates the final cash surrender value, accounting for any charges, and disburses the funds, followed by a final confirmation of policy termination.

Accessing Accelerated Death Benefits

Accelerated death benefits, also known as “living benefits,” allow a policyholder to access a portion of their life insurance policy’s death benefit while still alive. These benefits are available through riders or provisions within the policy. Qualifying conditions include a terminal illness with a prognosis of 24 months or less, or a chronic illness requiring long-term care. Some policies also include critical illness triggers, such as a heart attack, stroke, or cancer.

The amount received through accelerated death benefits will reduce the final death benefit paid to beneficiaries. These benefits are not taxable if the policyholder is certified as terminally or chronically ill, provided specific IRS guidelines are met. However, if payments are received in installments, any interest accrued might be taxable.

The claims process for accelerated death benefits requires medical documentation from a physician to substantiate the qualifying condition. After submitting a claim form to the insurer, an independent medical review may occur. Once approved, the funds are disbursed, and the insurer may deduct an administrative fee.

Selling Your Policy

Selling a life insurance policy to a third party is another way to access funds, through a viatical settlement or a life settlement. A viatical settlement is for terminally ill individuals, with a life expectancy of 24 months or less. A life settlement applies to individuals who are not terminally ill but meet age and health criteria, often those over 65. In both cases, the policy is sold to an investor for a lump sum that is more than the cash surrender value but less than the full death benefit.

The buyer becomes the new owner and beneficiary of the policy, assuming responsibility for all future premium payments and receiving the death benefit upon the insured’s passing. Viatical settlements are tax-free for the seller under the Health Insurance Portability and Accountability Act (HIPAA) of 1996, provided life expectancy criteria are met. Life settlements are taxable; proceeds are taxed in tiers: tax-free up to the cost basis, then as ordinary income up to the cash surrender value, and any amount above that as capital gains.

The process involves contacting a life settlement broker or provider. The policyholder submits an application along with medical records for evaluation, and if eligible, receives offers from potential buyers. If an offer is accepted, ownership of the policy is formally transferred to the buyer. This is a complex financial transaction with legal and tax considerations, making professional guidance advisable.