Can Whole Life Insurance Be Cashed Out?

Whole life insurance is a type of permanent life insurance that provides coverage for the insured person’s entire life. It combines a guaranteed death benefit, paid to beneficiaries upon the insured’s passing, with a savings component known as cash value. This cash value accumulates over time, offering a living benefit that policyholders can access during their lifetime. The ability to access this accumulated cash value makes whole life insurance a versatile financial tool.

Understanding Cash Value Accumulation

Cash value is a distinct component within a whole life insurance policy. A portion of each premium payment contributes to this cash value, which then accumulates interest on a tax-deferred basis. This means taxes on the growth are not due until the money is accessed, allowing the cash value to compound more efficiently over time.

The growth of cash value is guaranteed by the insurance company, often at a fixed interest rate. For participating whole life policies, policyholders may also receive dividends, which are a share of the insurer’s profits. These dividends, though not guaranteed, can be reinvested to purchase additional insurance or increase the cash value, further enhancing its growth.

Methods for Accessing Cash Value

Policyholders have several ways to access the accumulated cash value within their whole life insurance policy. Each method offers different benefits and consequences for the policy and its death benefit.

Policy Surrender

One direct method to access cash value is to surrender the policy. This involves canceling the insurance contract entirely and receiving the cash surrender value, which is the accumulated cash value minus any surrender charges or outstanding loans. Surrendering the policy terminates coverage, meaning no death benefit will be paid to beneficiaries. This option provides a lump sum of money but removes the future financial protection the policy offered.

Policy Loans

Policyholders can borrow money directly from the insurance company, using the policy’s cash value as collateral. This type of loan does not require a credit check or a lengthy approval process, as the cash value secures the borrowing. The policy remains in force, and the cash value continues to grow, although interest accrues on the outstanding loan balance. If the loan is not repaid, the outstanding amount, including accrued interest, will reduce the death benefit paid to beneficiaries. Insurance companies allow borrowing up to a certain percentage of the cash value, often around 90%.

Withdrawals (Partial Surrenders)

Accessing cash value can also be done through withdrawals, sometimes referred to as partial surrenders. This allows a policyholder to take out a portion of the accumulated cash value without fully terminating the policy. Unlike loans, withdrawals reduce the cash value directly and permanently, and they also decrease the policy’s death benefit by the amount withdrawn. While withdrawals provide direct access to funds, they can diminish the policy’s future growth potential and the ultimate payout to beneficiaries.

Tax Considerations for Accessing Cash Value

Accessing the cash value of a whole life insurance policy has specific tax implications that vary depending on the method used.

Surrender

When a whole life policy is surrendered, any amount received that exceeds the policyholder’s “cost basis” is considered taxable income. The cost basis refers to the total premiums paid into the policy, less any dividends received or prior withdrawals. For example, if a policyholder paid $50,000 in premiums and receives $70,000 upon surrender, the $20,000 gain is taxable as ordinary income, not as a capital gain. This tax liability can arise even if the policy has outstanding loans at the time of surrender, as the loan amount may be deducted from the cash value, but the gain remains taxable.

Policy Loans

Policy loans are not considered taxable income when received, as they are treated as a debt against the policy’s cash value, not as a withdrawal of earnings. This tax-free status holds as long as the policy remains in force. However, if the policy lapses or is surrendered with an outstanding loan, the loan amount, to the extent it exceeds the cost basis, can become taxable. This can result in taxes owed on gains even if the cash value has been depleted by the loan. Interest on policy loans is not tax-deductible.

Withdrawals

Withdrawals from a whole life policy are treated on a “first-in, first-out” basis for tax purposes. This means amounts withdrawn are considered a return of the premiums paid (the cost basis) first, and these amounts are tax-free. Once total withdrawals exceed the cost basis, any further amounts withdrawn are considered taxable income, as they represent the policy’s earnings. For instance, if $10,000 in premiums were paid and a $15,000 withdrawal is made, the first $10,000 is tax-free, but the remaining $5,000 is taxable.

Policy Changes After Accessing Cash Value

Accessing the cash value of a whole life insurance policy has direct and lasting effects on the policy itself, extending beyond immediate tax implications. These changes impact the policy’s future performance and benefits.

When a policy is surrendered, it is completely terminated. The policyholder receives the cash surrender value, and the contractual relationship with the insurer concludes.

Taking a policy loan reduces the net death benefit payable to beneficiaries if the loan, plus any accrued interest, is not repaid before the insured’s death. While the cash value continues to grow, the outstanding loan balance acts as a lien against the policy. If interest on the loan is not paid, it can be added to the loan principal, causing the loan balance to grow and potentially erode the cash value. If the loan amount, including accrued interest, exceeds the cash value, the policy can lapse, resulting in a loss of all coverage.

Withdrawals from a whole life policy permanently reduce both the policy’s cash value and its death benefit. Unlike loans, which can be repaid, withdrawals are irreversible. This reduction in cash value can slow down the policy’s future growth potential, as there is a smaller base on which interest and dividends can accumulate. The diminished cash value and death benefit may affect the policy’s ability to serve long-term financial goals.