Can You Cash Out on Life Insurance?

Life insurance primarily serves as a financial safety net, offering a death benefit to beneficiaries upon the policyholder’s passing. Certain types of life insurance policies can also develop a cash value over time. This cash value operates as a savings component, accessible during the policyholder’s lifetime under specific conditions. Understanding how this cash value accumulates and its utilization methods is important for policyholders.

Policies That Accumulate Cash Value

Life insurance policies fall into two categories: term life and permanent life. Term life provides coverage for a specific period and does not build cash value. Permanent life policies offer lifelong coverage and include a cash value component that grows over time.

Whole life insurance is a common type of permanent life insurance, characterized by fixed premiums and a guaranteed cash value growth rate. The cash value increases predictably based on an interest rate set by the insurer, and the death benefit is also guaranteed. A portion of each premium payment contributes to the cash value, which earns interest on a tax-deferred basis, allowing it to compound over time.

Universal life (UL) insurance offers more flexibility in premium payments and death benefits than whole life policies. Its cash value growth is often tied to interest rates, with many policies offering a guaranteed minimum interest rate. Policyholders can adjust their premiums, with excess payments contributing to the cash value.

Variable universal life (VUL) insurance introduces an investment component, allowing policyholders to allocate their cash value among sub-accounts, similar to mutual funds. The cash value growth is directly linked to the performance of these investments, offering potential for higher returns but also carrying market risk. This policy provides greater control over investment choices, though it requires more active management.

Ways to Access Cash Value

Policyholders can access cash value in their permanent life insurance policies through several methods, each with its own mechanics and implications. These options provide financial flexibility, but it is important to understand how each affects the policy’s continued coverage and benefits.

A common method is taking a policy loan, where the policyholder borrows money from the insurer, using the policy’s cash value as collateral. The policy remains in force, and the cash value continues to grow, although any outstanding loan amount, plus accrued interest, will reduce the death benefit. While repayment of the loan is often flexible, interest does accrue, and if left unpaid, it can increase the loan balance, potentially leading to a policy lapse if the loan exceeds the cash value.

Another option is a cash withdrawal, also known as a partial surrender. This involves taking out a portion of the policy’s cash value. A withdrawal directly reduces the policy’s cash value and results in a proportional decrease in the death benefit. This reduction is permanent, and while it provides immediate access to funds, it lessens the future payout to beneficiaries and can affect the policy’s long-term viability if too much cash value is removed.

The third method is a full policy surrender, which involves canceling the entire life insurance policy in exchange for its cash surrender value. This action terminates the policy, ending all coverage and the death benefit. The amount received is the cash value minus any applicable surrender charges, which can be substantial, especially in the early years of the policy.

Financial and Tax Considerations

Accessing life insurance cash value involves important financial and tax considerations that can significantly impact policyholders and their beneficiaries. Understanding these implications is crucial before making decisions.

When withdrawing cash from a policy, the amount received up to the policy’s “basis” (the total premiums paid) is tax-free, as it is considered a return of principal. However, any amount withdrawn that exceeds this basis, representing the policy’s earnings, is subject to taxation as ordinary income. For example, if $50,000 in premiums were paid and $80,000 is withdrawn, the first $50,000 is tax-free, but the remaining $30,000 is taxable.

Policy loans are not considered taxable income as long as the policy remains in force. However, if the policy lapses or is fully surrendered with an outstanding loan, the loan amount that exceeds the policy’s basis can become taxable income. This can arise if the loan balance, including accrued interest, grows to a point where it depletes the policy’s cash value, causing it to terminate.

An important consideration is whether the policy is classified as a Modified Endowment Contract (MEC) under Internal Revenue Code Section 7702A. If a policy becomes an MEC, withdrawals and loans are taxed on a “last-in, first-out” (LIFO) basis, meaning earnings are distributed first and are fully taxable. Distributions from an MEC made before age 59½ may be subject to a 10% federal income tax penalty, similar to distributions from qualified retirement plans.

Upon full policy surrender, any amount received that exceeds the total premiums paid into the policy is taxable as ordinary income. The insurer will provide a Form 1099-R if the cash surrender value exceeds the premiums paid, indicating the taxable portion. If the cash value received is less than the total premiums paid, a deductible loss is not recognized for tax purposes.

Each method of accessing cash value impacts the death benefit. Loans reduce the death benefit by the outstanding loan amount plus interest, while withdrawals directly decrease it. A full surrender eliminates the death benefit entirely. Policy loans also accrue interest, ranging from 5% to 8%, which can be fixed or variable, and if unpaid, this interest adds to the loan balance, further eroding the death benefit or accelerating a policy lapse. Surrender charges, which are fees deducted from the cash value if a policy is surrendered within a specific period, also reduce the final payout, particularly in the policy’s early years.

Steps to Request Cash Value Access

Initiating a request to access your life insurance policy’s cash value involves practical steps to ensure a smooth process. Preparation is important before contacting your insurance provider.

Begin by gathering all relevant policy information, including your policy number and current policy statements. These documents provide details about your accumulated cash value and any outstanding loan balances. If you do not have recent statements, you can access this information through your insurer’s online portal or by contacting their customer service department to request a current policy illustration or value statement. Understanding your specific policy’s terms and conditions related to cash value access, such as any waiting periods or minimum cash value requirements, is also important.

Once prepared, you can initiate the request by contacting your insurance company. This can be done via phone, through their secure online portal, or by mail. Be prepared to specify your desired method of access, whether it is a policy loan, a cash withdrawal, or a full policy surrender. The insurer will then provide the necessary forms, such as a “Policy Loan Request Form” or a “Cash Withdrawal Request Form,” tailored to your request.

Carefully complete all sections of the provided forms, ensuring accuracy and providing any requested supporting documentation. This may include identification verification or banking information for direct deposit. After completing the forms, submit them according to the insurer’s instructions, which may involve mailing the original signed documents, uploading them through a secure online portal, or submitting them via secure email.

After submission, the processing time for cash value access requests can vary, ranging from a few business days to several weeks, depending on the insurer and the complexity of the request. Funds are commonly disbursed via check or direct deposit to your designated bank account. You should receive confirmation from the insurer once the transaction is complete, along with updated policy statements reflecting the changes to your cash value and death benefit.