Can I Withdraw From My Life Insurance Policy?

Life insurance policies serve as a financial safety net for beneficiaries, providing a payout upon the insured’s passing. Beyond this primary function, certain life insurance policies also feature a cash value component. This accumulated cash value can be accessed by the policyholder during their lifetime, offering a potential source of funds. Not all life insurance policies include this feature; term life insurance, for instance, does not build cash value. Permanent life insurance policies, however, are designed to accumulate value over time, creating options for policyholders to tap into these funds.

Types of Policies That Build Cash Value

Cash value represents a savings component within certain life insurance policies, distinct from the death benefit. A portion of each premium payment contributes to this cash value, which then grows over time, often on a tax-deferred basis. Term life insurance policies do not accumulate cash value. Several types of permanent life insurance policies are designed to build cash value:

Whole life insurance features a guaranteed death benefit, fixed premiums, and cash value that grows at a predictable, guaranteed interest rate.
Universal life insurance offers flexibility, allowing adjustments to premiums and death benefits, with cash value growth tied to interest rates set by the insurer, often with a guaranteed minimum.
Variable universal life insurance allows policyholders to invest the cash value in various sub-accounts, similar to mutual funds, offering potential for higher returns but also greater risk based on market performance.
Indexed universal life insurance links cash value growth to the performance of a specific stock market index, such as the S&P 500, typically with a floor to protect against losses and a cap on gains.

Ways to Access Your Policy’s Value

Policyholders with cash value life insurance have several methods to access the accumulated funds.

Policy Loan

The policyholder borrows money from the insurer using the cash value as collateral. This is a loan from the insurance company, not a withdrawal of the cash value itself. Policy loans typically accrue interest, and if the loan and its interest are not repaid, the outstanding balance will reduce the death benefit paid to beneficiaries.

Cash Withdrawal (Partial Surrender)

This involves directly taking a portion of the accumulated cash value from the policy. A cash withdrawal permanently reduces both the policy’s cash value and the death benefit. Unlike a loan, a withdrawal does not need to be repaid, but it directly decreases the policy’s future value and payout.

Full Surrender

A policyholder can choose a full surrender of the policy. This action terminates the life insurance policy entirely, and the death benefit ceases to exist. Upon full surrender, the policyholder receives the cash surrender value, which is the accumulated cash value minus any surrender charges or outstanding loans. This option provides immediate access to the entire available cash value but ends the insurance coverage.

Financial Implications of Accessing Policy Value

Accessing a life insurance policy’s cash value carries various financial consequences that extend beyond the immediate receipt of funds.

Tax Considerations

Policy loans are generally not considered taxable income, provided the policy remains in force. However, if the policy lapses with an outstanding loan, the amount borrowed that exceeds the premiums paid may become taxable. Cash withdrawals are typically tax-free up to the amount of premiums paid into the policy (the cost basis), but any amount withdrawn beyond the cost basis is usually taxable as ordinary income. When a policy is fully surrendered, any gain, which is the cash surrender value exceeding the total premiums paid, is subject to taxation.

The classification of a policy as a Modified Endowment Contract (MEC) can significantly alter the tax treatment of withdrawals and loans. A policy becomes an MEC if it fails the “seven-pay test,” meaning premiums paid exceed certain IRS limits within the first seven years. For MECs, withdrawals and loans are taxed on a “last-in, first-out” (LIFO) basis, meaning gains are considered withdrawn first and are fully taxable, potentially incurring a 10% penalty if the policyholder is under age 59½. This differs from non-MEC policies where withdrawals are generally treated as tax-free return of basis first.

Impact on Death Benefit

The death benefit payable to beneficiaries is directly impacted by any access to cash value. Outstanding policy loans, as well as partial withdrawals, reduce the death benefit dollar-for-dollar. A full surrender eliminates the death benefit entirely, as the policy is terminated.

Risk of Policy Lapse

Accessing cash value can also introduce the risk of policy lapse. If a policy loan’s interest accrues to the point where the total loan balance, including interest, exceeds the policy’s cash value, the policy may lapse without coverage. Similarly, substantial cash withdrawals can deplete the cash value, potentially leaving insufficient funds to cover ongoing policy charges and premiums. This can lead to a lapse if premiums are not paid out-of-pocket.

Future Premium Payments

Future premium payments may also be affected by accessing cash value. For universal life policies, the cash value can sometimes be used to cover premiums, offering flexibility. However, if the cash value is significantly reduced by loans or withdrawals, it may no longer be sufficient to cover these costs, requiring the policyholder to resume or increase out-of-pocket premium payments to keep the policy in force. Neglecting to do so could result in the policy lapsing, ending coverage.

Steps to Access Your Policy’s Value

Accessing your life insurance policy’s cash value involves a straightforward administrative process.

Contact the Insurer: The initial step is to contact your life insurance company directly. This can typically be done through their customer service line, official website, or by reaching out to your assigned insurance agent.
Provide Information: When you contact the insurer, be prepared to provide essential information to verify your identity and policy details. You will likely need your policy number, personal identification, and a clear indication of the amount you wish to access and the preferred method of access (e.g., loan, withdrawal, or full surrender). The insurance company will then guide you on the specific forms required for your request.
Complete Forms: The insurer will provide the necessary forms, which are specifically designed for policy loans, cash withdrawals, or full surrender requests. These forms will require you to accurately complete sections with your personal and policy information. It is important to review these documents carefully to ensure all details are correct and that you understand the terms associated with the transaction.
Submit and Process: Once the forms are completed, they can be submitted through the channels specified by your insurer, which often include mail, an online portal, or fax. After submission, there will be a processing period, which can vary but typically ranges from a few business days to a few weeks. The insurer will provide confirmation once the request is processed and disburse the funds according to your chosen method. It is always advisable to review your original policy documents for specific terms and conditions regarding cash value access, as individual policy provisions can vary.