Can I Withdraw Money From My Life Insurance?

Life insurance policies are primarily designed to provide a financial safety net for your loved ones after you pass away. While the main purpose is a death benefit, certain types of policies can accumulate a cash value, offering a potential source of funds. This feature provides flexibility beyond the traditional death benefit. Understanding how to access these funds involves knowing the specific policy structure and its financial implications.

Understanding Life Insurance Cash Value

Life insurance policies generally fall into two main categories: term life and permanent life insurance. Term life insurance provides coverage for a specific period, such as 10, 20, or 30 years, and typically does not build cash value. Permanent life insurance, including whole life, universal life, variable universal life, and indexed universal life, provides coverage for your entire lifetime and often includes a cash value component.

The cash value is a distinct component within a permanent life insurance policy that grows over time on a tax-deferred basis, separate from the death benefit. A portion of each premium payment contributes to this cash value account, while other portions cover the cost of insurance and administrative expenses. This accumulated cash value can grow through guaranteed interest rates, declared dividends, or investment performance, depending on the specific policy type.

Ways to Access Life Insurance Cash Value

Several methods allow policyholders to access the accumulated cash value from a permanent life insurance policy.

Policy Loans

One common method is taking a policy loan. This is an advance from the insurance company, with the policy’s cash value serving as collateral. Policy loans typically do not require credit checks, and repayment terms can be flexible. Interest accrues on the loan, and any outstanding loan balance, including unpaid interest, will reduce the death benefit paid to beneficiaries upon the insured’s passing.

Cash Withdrawals

Policyholders may also opt for direct cash withdrawals from their policy’s accumulated cash value. Unlike a loan, a withdrawal directly removes funds from the cash value account, which permanently reduces the policy’s cash value and typically results in a corresponding reduction in the death benefit. Excessive withdrawals can diminish the cash value to a point where it can no longer cover policy charges, potentially leading to the policy lapsing if additional premiums are not paid.

Policy Surrender

Surrendering a life insurance policy means terminating the contract entirely. Upon surrender, the policyholder receives the “cash surrender value,” which is the accumulated cash value minus any applicable surrender fees or outstanding loans. Surrender charges are common, especially in the early years of a policy, and can significantly reduce the amount received. Surrendering the policy ends all insurance coverage, meaning no death benefit will be paid to beneficiaries.

Financial and Tax Implications

Accessing life insurance cash value has financial and tax implications. Tax treatment varies by access method and policy status.

Taxation

Policy loans are generally not considered taxable income as long as the policy remains in force. However, if the policy lapses or is surrendered with an outstanding loan, the amount of the loan that exceeds the premiums paid (cost basis) can become taxable as ordinary income. Cash withdrawals are typically tax-free up to the amount of premiums paid into the policy, known as the “cost basis.” Any amount withdrawn beyond this cost basis is usually considered taxable income and taxed at ordinary income rates. When a policy is surrendered, any gain—the cash value received in excess of the premiums paid—is taxable as ordinary income.

A Modified Endowment Contract (MEC) status is important. If a life insurance policy is overfunded according to IRS rules, usually by paying too much premium within the first seven years, it can be reclassified as an MEC. Once a policy becomes an MEC, distributions, including withdrawals and policy loans, are treated differently for tax purposes. All distributions from an MEC are taxed on a “last-in, first-out” (LIFO) basis, meaning earnings are considered distributed first and are fully taxable as ordinary income. If the policyholder is under age 59½, a 10% federal income tax penalty may apply to the taxable portion of the distribution.

Impact on Death Benefit

Any access to the policy’s cash value, whether through loans or withdrawals, will reduce the death benefit paid to beneficiaries. An outstanding policy loan, along with any accrued interest, is directly deducted from the death benefit upon the insured’s death. Cash withdrawals permanently decrease the policy’s face amount or the amount available to beneficiaries. Surrendering the policy entirely eliminates the death benefit, as insurance coverage ceases.

Impact on Policy Performance

Accessing the cash value can also affect the policy’s future growth and its ability to remain in force. When funds are withdrawn, the remaining cash value is smaller, which can reduce the potential for future interest accumulation or dividend payments. If cash value is used to cover policy charges, a significant reduction can lead to insufficient funds to maintain the policy, potentially causing it to lapse if additional premiums are not paid.

Key Considerations Before Taking Action

Review your policy document to understand the terms, conditions, fees, and interest rates for loans, withdrawals, or surrender. Each policy can have unique rules.

Consider your long-term financial goals and how accessing these funds might impact them. Accessing cash value affects financial security and estate planning, including the death benefit. Evaluate whether this action aligns with your broader financial strategy.

Explore alternative financial options before drawing from your life insurance policy. Consider personal savings, other investment accounts, or traditional loans from banks or credit unions, which might offer more favorable terms or fewer long-term consequences. Utilizing other resources first could preserve your life insurance coverage and its benefits.

Consult a qualified financial advisor or tax professional. They can provide personalized advice on the implications of accessing your policy’s cash value based on your financial and tax situation. Their expertise can help navigate complex rules and identify the most suitable course of action.