Can I Withdraw Cash Value From Life Insurance?

Cash value in life insurance refers to a component of certain permanent life insurance policies that accumulates over time. This accumulated amount grows on a tax-deferred basis, meaning earnings are not taxed until they are withdrawn. Policyholders can access this cash value during their lifetime, providing a financial resource in addition to the death benefit.

Understanding Policies with Cash Value

Different types of life insurance policies accumulate cash value, each with distinct growth characteristics. Whole life insurance provides guaranteed cash value growth, fixed premiums, and a guaranteed death benefit, building predictably. Universal life insurance offers flexibility in premium payments and death benefits, with cash value growth tied to an insurer-set interest rate, allowing adjustments for changing financial needs. Variable universal life insurance allows policyholders to invest the cash value in various sub-accounts, similar to mutual funds. This offers potential for higher growth but also carries higher risk, as the cash value can fluctuate with market performance. Understanding these policy types helps determine if a policy includes a cash value component.

Methods for Accessing Cash Value

Policyholders have several ways to access the cash value within their permanent life insurance policies. A direct cash value withdrawal removes funds from the policy, reducing its cash value and decreasing the death benefit. Withdrawals are generally tax-free up to the premiums paid (cost basis); amounts exceeding this may be taxable.

Policyholders can also take a policy loan, borrowing from the insurer using cash value as collateral. Loans accrue interest, which must be repaid or added to the outstanding balance. If the policyholder dies, the outstanding loan is deducted from the death benefit. Loans are typically tax-free while the policy remains in force, but if the loan balance exceeds the cash value, the policy may lapse, potentially triggering a taxable event.

Policy surrender involves terminating the insurance policy. Upon surrender, the policyholder receives the cash surrender value, which is the cash value minus any outstanding loans and applicable surrender charges. Surrendering a policy ends all coverage, forfeiting the death benefit. Any gain (cash surrender value exceeding total premiums paid) is considered taxable income.

Tax Implications of Accessing Cash Value

Accessing cash value carries specific tax implications depending on the method used and the policy’s characteristics. For withdrawals from non-Modified Endowment Contracts (MECs), the “first-in, first-out” (FIFO) rule applies. Withdrawals are considered a tax-free return of the policyholder’s cost basis (total premiums paid) before earnings are taxed. Only amounts exceeding this cost basis are taxable income.

Policy loans from non-MEC policies are generally not taxable events. However, if a policy with an outstanding loan lapses or is surrendered, the loan amount exceeding the policy’s cost basis may become taxable income, creating an unexpected tax liability.

When a policy is surrendered, any realized gain is subject to taxation. The taxable gain is calculated as the cash surrender value received minus total premiums paid. This gain is typically taxed as ordinary income, not capital gains, and can increase the policyholder’s tax liability.

A Modified Endowment Contract (MEC) is a life insurance policy that has received premiums exceeding federal tax law limits, specifically failing the “7-pay test.” Once classified as a MEC, its tax treatment changes. Withdrawals and loans from a MEC are subject to the “last-in, first-out” (LIFO) rule, meaning gains are taxed first as ordinary income before any return of basis. A 10% federal penalty tax may also apply to taxable distributions if the policyholder is under age 59½.

Steps to Access Cash Value

To access your life insurance policy’s cash value, contact your insurance carrier. Policyholders can typically reach their insurer via phone, online portal, or through their agent. The company will then provide specific forms for the desired transaction, whether a withdrawal, policy loan, or full surrender.

Before submitting the request, gather necessary information, including the policy number, desired cash value amount, and bank account details for direct deposit. Forms will also require the policyholder’s signature. Once completed, these forms can usually be submitted to the insurer through mail, an online portal, or fax.

Processing times vary depending on the insurer and request type. For withdrawals or loans, funds may be disbursed within a few business days to a few weeks. Policy surrenders typically take 14 to 60 days for funds to be received after approval. Before finalizing any request, confirm the exact cash value available, understand potential fees, and verify the impact on the policy’s death benefit.