Can I Take Money Out of My Life Insurance Policy?

While primarily designed to provide financial security to beneficiaries after the insured’s passing, certain life insurance policies also allow access to accumulated value during the insured’s lifetime. The way these funds can be accessed and the implications depend on the specific policy structure and the method chosen.

Understanding Cash Value Life Insurance

Cash value in a life insurance policy represents a savings component that accumulates over time, separate from the death benefit. This accumulated value grows on a tax-deferred basis, meaning earnings are not taxed until withdrawn. This feature distinguishes permanent life insurance policies from term life insurance.

Policies that build cash value are permanent life insurance, such as whole life, universal life, and variable universal life. Whole life offers guaranteed cash value growth at a fixed interest rate. Universal life provides flexibility in premium payments and death benefits, with cash value growth often tied to current interest rates. Variable universal life policies allow the policyholder to invest the cash value in various sub-accounts, where growth or loss depends on investment performance.

In contrast, term life insurance does not build cash value. It provides coverage for a specific period, typically 10 to 30 years, and expires without accumulated value if the insured outlives the term. A portion of each premium payment for cash value policies contributes to this fund, with the remainder covering the cost of insurance and administrative fees.

Accessing Funds Through Policy Loans

A policy loan allows a policyholder to borrow money against their cash value, using it as collateral. This is an advance from the insurer, not a traditional bank loan. Interest accrues on the loan, but there is no strict repayment schedule, offering flexibility. However, any outstanding loan balance will reduce the death benefit paid to beneficiaries if the insured passes away before repayment.

To request a policy loan, contact the insurer with your policy number and desired loan amount. The process involves submitting a loan request form, often through customer service or a policyholder portal. Funds are typically disbursed within a few days to a couple of weeks.

Policy loans are tax-free as long as the policy remains in force. An exception arises if the policy lapses or is surrendered with an outstanding loan, as the untaxed loan amount may then become taxable income. This is particularly relevant for Modified Endowment Contracts (MECs), which are policies funded with too much premium in the first seven years. Loans or withdrawals from MECs are subject to “last-in, first-out” (LIFO) taxation and a potential 10% penalty if the policyholder is under age 59½.

An outstanding loan reduces the policy’s cash value, as the borrowed amount no longer earns interest or investment returns. This impacts the policy’s long-term growth potential. If the loan plus accrued interest exceeds the policy’s cash value, the policy could lapse, triggering a taxable event.

Accessing Funds Through Withdrawals

A withdrawal, also known as a partial surrender, involves permanently removing a portion of the cash value from a life insurance policy. Unlike a loan, a withdrawal directly reduces the policy’s cash value and the death benefit by the amount taken out. The withdrawn funds cannot be repaid to restore the death benefit.

To initiate a withdrawal, contact the insurance company with your policy number and desired amount. The procedure involves completing a withdrawal request form and submitting it for processing. Funds are usually disbursed within a few business days or weeks after approval.

The tax implications of withdrawals are governed by the “cost basis” rule. Withdrawals are tax-free up to the amount of premiums paid into the policy, as this is considered a return of the policyholder’s own money. Any amount withdrawn exceeding the total premiums paid (the cost basis) is considered taxable income. For MECs, withdrawals are taxed on a “last-in, first-out” (LIFO) basis, meaning earnings are considered withdrawn first, making them immediately taxable. Withdrawals from MECs before age 59½ may also incur a 10% federal income tax penalty.

Withdrawals can significantly impact the policy’s future viability. Reducing the cash value diminishes the policy’s ability to cover future policy charges, potentially leading to a lapse if insufficient funds remain. A reduced cash value also means less money available for future loans or to supplement retirement income.

Cashing Out Your Life Insurance Policy

Cashing out a life insurance policy means surrendering the contract to the insurer for its cash surrender value, which terminates the policy. This results in the complete loss of life insurance coverage and the death benefit.

The cash surrender value is the accumulated cash value minus any applicable surrender charges and outstanding loans. Surrender charges are fees insurers may impose, especially during the early years of a policy, to recoup upfront costs. These charges can significantly reduce the amount received, particularly if the policy is surrendered within the first 10 to 15 years.

To surrender a policy, contact the insurer, provide your policy number, and submit a formal surrender request form. This process formally initiates the termination of your coverage.

The amount received upon surrendering a policy is subject to taxation if it exceeds the premiums paid into the policy (the cost basis). The taxable gain is calculated as the cash surrender value received minus total premiums paid. This gain is taxed as ordinary income. For example, if a policyholder paid $50,000 in premiums and receives $65,000 upon surrender, the $15,000 difference is taxable.

The most significant consequence of cashing out a policy is the irreversible termination of the death benefit, leaving beneficiaries without financial protection. This decision eliminates future financial security for dependents.