Can You Cash Out Your Life Insurance Policy?

Life insurance policies primarily provide financial security to beneficiaries upon the policyholder’s death. However, some policies also include a “cash value” component accessible during the policyholder’s lifetime. Understanding how cash value works, how to access it, and its financial and tax implications is crucial for informed decisions about your coverage.

Understanding Cash Value Life Insurance

Cash value is the savings component within permanent life insurance policies. Unlike term life, which covers a specific period and doesn’t build cash value, permanent policies offer lifelong coverage and accumulate this fund. Common types include whole life, universal life, and variable universal life insurance.

Cash value accumulates over time from a portion of premiums paid. After covering insurance costs and fees, the rest is allocated to the cash value account, growing tax-deferred. Growth varies by policy type: whole life policies offer a guaranteed interest rate, while universal life policies may grow based on current rates or market performance with a guaranteed minimum. Variable universal life policies allow investment in sub-accounts, offering higher growth potential but also increased risk.

Distinguish between cash value and the death benefit. The death benefit is the amount paid to beneficiaries upon the insured’s death, generally tax-free. Cash value is a living benefit accessible by the policyholder while alive. While cash value can grow significantly, it does not directly transfer to beneficiaries upon death; the death benefit is usually paid out.

Ways to Access Your Policy’s Cash Value

Policyholders can access their permanent life insurance policy’s cash value through several methods. Each method has distinct implications for the policy’s continuation and death benefit.

A policy loan uses the cash value as collateral. Loans generally don’t require credit checks and often have interest rates from 5% to 8%. The policy remains in force, usually without a strict repayment schedule. However, any outstanding loan balance, plus accrued interest, reduces the death benefit if not repaid before death. If the loan and interest exceed the cash value, the policy can lapse, potentially causing tax consequences.

A partial withdrawal allows the policyholder to remove a portion of the cash value directly. Unlike a loan, a withdrawal permanently reduces the policy’s cash value and death benefit. Withdrawals can impact the policy’s long-term performance and may lead to its lapse if the cash value falls too low to cover charges.

A policy surrender terminates the entire life insurance contract for its cash surrender value. This ends coverage, meaning no death benefit is paid. The cash surrender value is the cash value minus any surrender charges and outstanding loans or withdrawals. Surrendering a policy means giving up lifelong coverage.

Financial and Tax Considerations

Accessing a life insurance policy’s cash value involves financial and tax implications. The tax treatment of withdrawals and loans differs significantly.

Withdrawals from a life insurance policy are generally tax-free up to the policy’s “cost basis.” This cost basis is the total premiums paid, reduced by any prior tax-free distributions. Any amount withdrawn exceeding this cost basis, representing policy gains, is taxable as ordinary income. Policy loans, however, are generally not taxable income as long as the policy remains in force. The IRS views these as a debt against the policy’s value, not a distribution of gains.

However, policy loans can become taxable in specific scenarios. If a policy with an outstanding loan lapses or is surrendered, the unpaid loan amount, including accrued interest, can become taxable income if it exceeds the policy’s cost basis. This is relevant if the policy is a Modified Endowment Contract (MEC). An MEC is a policy that received premiums exceeding certain IRS limits within the first seven years. Withdrawals and loans from an MEC are subject to “last-in, first-out” (LIFO) taxation, meaning gains are taxed first, and a 10% penalty may apply if the policyholder is under age 59½.

Surrender charges are fees insurance companies may impose if a policy is surrendered, or for partial withdrawals, especially in early years. These charges can significantly reduce the cash received upon surrender, particularly within the first 10 to 15 years, sometimes starting as high as 10% of the cash value. Any use of cash value through loans or withdrawals directly reduces the death benefit payable to beneficiaries.

Steps to Request Cash Value

Requesting access to your policy’s cash value typically involves direct communication with your insurance provider. First, contact your insurance company, either customer service or your agent. This allows you to discuss your intent and confirm available options for your policy.

After discussing options, the insurance company will provide forms for your chosen access type: a policy loan, partial withdrawal, or full surrender. These forms require accurate information, including your policy number, the specific amount, and your signature. Review all sections and instructions carefully for proper completion.

Submit the completed forms to the insurance company. Submission methods often include mailing original documents, or sometimes via an online portal or fax. After submission, the company will process the request, which can take days to weeks depending on complexity and processing times. You will receive funds via check or direct deposit once complete.