Can I Withdraw Money From My Term Life Insurance?

Term life insurance provides financial protection for loved ones for a specific period. Many individuals considering this coverage often wonder if they can access funds from their policy during their lifetime. This article will explore the nature of term life insurance, how it differs from other policy types, and the limited ways policyholders might access funds.

How Term Life Insurance Works

Term life insurance is a contract between an individual and an insurance company, providing coverage for a defined period. This period ranges from 10 to 30 years, during which the policyholder pays fixed premiums. If the insured person dies within this term, the insurance company pays a death benefit to the designated beneficiaries. The primary purpose of term life insurance is to replace income and cover financial obligations, such as a mortgage or children’s education, should the insured pass away unexpectedly.

Unlike some other forms of life insurance, term policies are considered “pure protection.” This means the premiums are calculated to cover only the cost of the death benefit for the specified term. Term life insurance policies do not accumulate a cash value over time. If the policyholder outlives the term, the coverage simply expires, and no payout or refund of premiums occurs unless a specific “return of premium” rider was purchased, which increases the premium cost.

Distinguishing Term from Permanent Life Insurance

The question of accessing policy value stems from the difference between term and permanent life insurance. Permanent life insurance, such as whole life or universal life, offers coverage for the insured’s entire life, not just a set term. These policies have a cash value component that grows over time on a tax-deferred basis, similar to a savings account.

Policyholders can access this accumulated cash value during their lifetime, through policy loans or withdrawals. These options provide a flexible source of funds, which can be used for various financial needs. In contrast, term life insurance does not include this cash value feature. The premiums for permanent policies are higher than for term policies due to their lifelong coverage and cash value accumulation.

Options for Accessing Policy Value (Beyond Traditional Withdrawal)

While term life insurance does not have a cash value for traditional withdrawals, there are limited circumstances where policyholders might access funds from their policy. These methods are not withdrawals of accumulated value but rather advances or sales of the death benefit. Two primary options are Accelerated Death Benefits and Life Settlements.

Accelerated Death Benefits (ADBs), also known as living benefits, are provisions in some life insurance policies that allow the policyholder to receive a portion of their death benefit while still alive. This is permitted under specific qualifying conditions, such as a diagnosis of terminal illness with a limited life expectancy, often 12 to 24 months, or a chronic or critical illness requiring long-term care. The amount received through an ADB reduces the death benefit paid to beneficiaries upon the insured’s passing. ADBs are not subject to federal income tax if the insured meets the IRS definition of terminally or chronically ill. However, exceptions can lead to taxation, such as when benefits for chronic illness exceed IRS per diem limits, or if the medical condition does not meet IRS definitions.

Life settlements offer another pathway to access funds, involving the sale of an existing life insurance policy to a third-party investor. This option is considered by older policyholders, often those over 65, or individuals with declining health and a life expectancy under 15 years. The policyholder receives a lump sum payment that is greater than the policy’s cash surrender value but less than the full death benefit. The investor then takes over premium payments and becomes the new owner and beneficiary of the policy.

The taxation of life settlement proceeds follows a three-tier structure. First, the portion of the payout equal to the premiums paid (cost basis) is tax-free. Second, any amount received above the cost basis up to the policy’s cash surrender value is taxed as ordinary income. Third, any remaining proceeds beyond the cash surrender value are taxed as capital gains. Viatical settlements, for terminally or chronically ill individuals, are tax-free.

What Happens When a Term Policy Ends

When a term life insurance policy reaches the end of its specified period, several outcomes are possible. If no action is taken, the policy simply expires, and coverage ceases. At this point, the policyholder receives no payout, and the beneficiaries would not receive a death benefit if the insured were to pass away after the expiration date.

Policyholders have the option to renew their term policy, but this comes with higher premiums. The increased cost reflects the insured’s older age and potentially changed health status, making renewal a less cost-effective option for many. Another option is a conversion privilege, which allows the policyholder to convert the term policy into a permanent life insurance policy. This conversion can occur without a new medical exam, but the premiums for the new permanent policy will be higher. Only after conversion would the policy begin to accumulate a cash value.