Can I Take Money Out of My Life Insurance?

Life insurance policies are primarily designed to provide a financial safety net for beneficiaries after the policyholder’s passing. Certain types of policies, however, also offer “living benefits” by allowing the policyholder to access accumulated funds during their lifetime. This ability to tap into policy value can provide financial flexibility for various needs. The structure of the policy determines whether such access is possible, and the methods chosen for accessing funds carry distinct consequences for both the policy and potential tax obligations.

Life Insurance Policies That Build Cash Value

Not all life insurance policies accumulate a cash value; this feature is primarily associated with permanent life insurance. Permanent policies, such as Whole Life, Universal Life (UL), and Variable Universal Life (VUL), include a savings component that grows over time. A portion of each premium payment contributes to this cash value, which can then accumulate on a tax-deferred basis, similar to some retirement accounts.

Whole Life insurance policies offer guaranteed cash value growth at a predictable interest rate, providing a stable accumulation. Universal Life policies offer more flexibility, allowing adjustments to premiums and death benefits, with cash value growth tied to an interest rate set by the insurer or market performance, potentially with a guaranteed minimum. Variable Universal Life policies link cash value growth to underlying investment sub-accounts, offering potential for higher returns but carrying greater risk due to market fluctuations. In contrast, term life insurance policies are designed to provide coverage for a specific period and do not build cash value.

Methods for Accessing Your Policy’s Cash Value

Policyholders with permanent life insurance have several ways to access the accumulated cash value within their policies. These methods offer different levels of flexibility and impact on the policy.

Policy loans allow you to borrow money from the insurer, using your policy’s cash value as collateral. The funds do not directly come out of your cash value; instead, the insurer lends you money, and your cash value continues to grow. To obtain a loan, contact your insurance company and request the desired amount, up to 90% of the cash value. There is no credit check or extensive approval process. Interest accrues on the loan, but repayment terms are flexible, with no fixed schedule or requirement to repay the principal.

Cash withdrawals involve directly taking money out of your policy’s cash value. This action reduces the policy’s cash value and, consequently, the death benefit. To initiate a withdrawal, contact your insurer and complete forms indicating the amount you wish to withdraw. Unlike loans, withdrawals permanently decrease the policy’s value and are not repaid.

Policy surrender involves terminating the life insurance policy entirely in exchange for its cash surrender value. This action ends the death benefit protection, meaning beneficiaries will receive no payout upon the insured’s death. To surrender a policy, contact your insurance company and submit a surrender request form. The insurer will calculate the cash surrender value, which is the accumulated cash value minus any outstanding loans and applicable surrender charges.

Tax Implications of Accessing Cash Value

Accessing your life insurance policy’s cash value can have various tax implications, depending on the method chosen. Tax laws are complex, and consulting a tax professional is advisable for specific situations.

Policy loans are not considered taxable income as long as the policy remains in force. This is because a loan is considered debt, not a distribution of gains. However, if the policy lapses or is surrendered with an outstanding loan, the loan amount, to the extent it represents a gain over the premiums paid, can become taxable income. This occurs if the loan balance plus accrued interest exceeds the policy’s cash value, causing the policy to terminate.

Cash withdrawals are tax-free up to the “cost basis,” which is the total amount of premiums paid into the policy. Any amount withdrawn that exceeds this cost basis is considered a gain and is taxable as ordinary income. For example, if you paid $10,000 in premiums and withdraw $12,000, the first $10,000 is tax-free, but the additional $2,000 is taxable.

When a policy is surrendered, any amount received that exceeds the total premiums paid (your cost basis) is taxable as ordinary income. If the cash surrender value is less than or equal to the total premiums paid, there is no taxable gain. Insurers may issue a Form 1099-R if the surrender value exceeds the premiums paid, indicating the taxable portion.

Impact on Your Policy

Accessing cash value from a life insurance policy directly affects its future viability and benefits, separate from any tax considerations. Understanding these impacts is important when deciding whether to utilize your policy’s living benefits.

Taking a policy loan or making a cash withdrawal directly reduces the death benefit payable to your beneficiaries. If a loan is not repaid, the outstanding balance, including any accrued interest, will be deducted from the death benefit when the insured passes away. Similarly, cash withdrawals permanently decrease the policy’s cash value, which translates to a lower death benefit. This reduction means less financial protection for your loved ones.

Outstanding policy loans can also increase the risk of policy lapse. If the loan balance, along with accumulated interest, grows to exceed the policy’s cash value, the insurer may terminate the policy. This can leave you without coverage and potentially trigger a taxable event if the outstanding loan amount exceeds your cost basis. Withdrawals also deplete the cash value, which could make it difficult for the policy to cover its internal charges, leading to a lapse if insufficient funds remain to sustain it.

Many permanent life insurance policies, especially in their early years, may impose surrender charges if the policy is terminated. These charges are deductions from the cash value when a policy is surrendered, reducing the amount the policyholder receives. Surrender charges typically decline over a period. Accessing cash value can also impact future premium payments, particularly for Universal Life policies. If cash value is significantly reduced through loans or withdrawals, there may be less available to cover policy charges, potentially requiring higher out-of-pocket premiums to maintain coverage.