Can You Cash Out a Universal Life Insurance Policy?

Universal life insurance provides both a death benefit and a cash value component, distinguishing it from term life policies. Policyholders may consider withdrawing or cashing out accumulated funds, but financial implications must be carefully evaluated.

Accessing funds isn’t always simple. Surrender fees, tax consequences, and policy conditions determine availability and potential costs. Understanding these factors helps avoid unexpected financial setbacks.

Cash Value Accumulation Basics

Universal life insurance builds cash value by allocating a portion of each premium payment to a savings-like account. Growth depends on interest rates set by the insurer, with a minimum guaranteed rate and a fluctuating current rate influenced by market conditions. Unlike whole life insurance, which offers fixed growth, universal life policies provide flexibility and the potential for higher returns when interest rates rise.

The growth rate varies by policy type. Traditional universal life earns interest based on the insurer’s declared rate. Indexed universal life ties growth to a stock market index, such as the S&P 500, while variable universal life allows investments in sub-accounts similar to mutual funds, offering higher growth potential but greater risk.

Cash value increases when premium payments exceed insurance costs and administrative fees. Paying only the minimum premium results in little accumulation, while higher payments accelerate growth. Some policies permit additional lump-sum contributions, but these must stay within IRS limits to avoid classification as a Modified Endowment Contract (MEC), which changes tax treatment.

Conditions to Access Insurance Funds

Withdrawing money depends on the method used and the policy’s terms. Some options allow access without affecting coverage, while others reduce or terminate the policy.

A policy loan lets the insurer lend money using the cash value as collateral. These loans typically have lower interest rates than personal loans or credit cards. However, unpaid interest accrues, and if the loan balance surpasses the cash value, the policy may lapse. Borrowing also reduces the death benefit unless repaid.

A partial withdrawal directly reduces cash value and may lower the death benefit. Some policies cap withdrawal amounts, and excessive withdrawals may require additional premium payments to maintain coverage. Unlike loans, withdrawals don’t need repayment, but amounts exceeding total premiums paid are taxable.

Surrendering the policy grants access to the full cash value, minus fees, but cancels the death benefit, eliminating financial protection for beneficiaries.

Potential Surrender Fees

Exiting a universal life policy early can trigger surrender charges, which insurers impose to recover costs. These fees are highest in the early years and decrease over time, often following a set schedule. A policy might have a 10-year surrender period, with fees starting at 10% of the cash value and decreasing by 1% each year until they disappear. Cashing out too soon can significantly reduce the payout.

Surrender fee structures vary. Some policies have a flat charge for a set number of years, while others use a declining percentage. Increasing the death benefit may reset the surrender period, leading to unexpected costs if the policy is later surrendered.

Surrendering can also mean losing built-in benefits. Some policies offer bonuses or enhanced interest credits that apply only if the policy remains active for a certain period. Canceling early forfeits these advantages. Insurers may also apply market value adjustments (MVAs) to policies tied to fixed-interest accounts. If interest rates have risen since the policy was issued, the surrender value may be reduced further to offset the insurer’s lost investment returns.

Tax Considerations

Universal life insurance allows tax-deferred cash value growth, meaning policyholders don’t pay taxes on gains while funds remain in the policy. However, tax consequences arise when withdrawing funds or taking loans.

The IRS follows the “first-in, first-out” (FIFO) rule for life insurance, allowing tax-free withdrawals up to the amount of total premiums paid (the cost basis). Any amount beyond this is taxable as ordinary income, which in 2024 ranges from 10% to 37%, depending on the individual’s tax bracket.

Policy loans aren’t taxable at the time of borrowing, but if the policy lapses with an outstanding loan, the IRS treats the unpaid balance as a distribution. Any portion exceeding the cost basis is then taxed as income, potentially creating an unexpected tax liability, especially if loan interest has accumulated.

Steps to Request the Funds

Accessing cash value requires following the insurer’s process, which differs based on whether the policyholder is taking a loan, making a withdrawal, or surrendering the policy.

To initiate a withdrawal or loan, the policyholder must contact the insurer, typically through an agent or customer service. Most insurers require a formal request, often via a withdrawal or loan form. Some allow online requests, while others require physical paperwork. Processing times range from a few days to a couple of weeks. If taking a loan, the insurer provides details on interest rates and repayment terms. For withdrawals, the insurer confirms whether the requested amount is within policy limits and how it affects the death benefit.

Surrendering a policy requires submitting a formal request, often with identification and banking details for fund disbursement. Some insurers require a notarized signature or acknowledgment of surrender charges. Once approved, the insurer processes the payout, deducting outstanding loans, surrender fees, and applicable taxes before issuing the final amount. Funds may be disbursed via direct deposit or check. Policyholders should review all final calculations to ensure accuracy and confirm that surrendering aligns with their financial plans.