Can You Cash Out Your Own Life Insurance Policy?

Accessing funds from a life insurance policy during your lifetime, often called “cashing out,” is possible with certain policy types. Only policies that accumulate cash value, where a portion of premiums contributes to a growing cash component, allow this. Understanding these policies and access methods is important for financial planning.

Policies That Build Cash Value

Life insurance policies fall into two main categories: term life and permanent life. Term life insurance covers a specific period (e.g., 10, 20, or 30 years) and does not build cash value; it only provides a death benefit if the insured dies within the term. Only permanent policies accumulate cash value.

Permanent life insurance offers lifelong coverage and includes a cash value component that grows over time. Whole life insurance, a common type, features guaranteed level premiums, a guaranteed death benefit, and cash value that grows at a predictable interest rate. Dividends from mutual insurance companies can further increase cash value and death benefit.

Universal life (UL) insurance is another form of permanent coverage that builds cash value, offering more flexibility than whole life. Policyholders can adjust premium payments and, within certain limits, the death benefit. The cash value in a universal life policy earns interest, often based on current market rates, with a guaranteed minimum interest rate.

Variable universal life (VUL) insurance policies also build cash value, but they allow the policyholder to invest the cash value in various subaccounts, similar to mutual funds. This offers potential for higher growth, but also carries investment risk. The cash value can fluctuate with market performance and may decrease.

Indexed universal life (IUL) is a variation where cash value growth is tied to a stock market index, such as the S&P 500. This provides potential for market-linked gains while often including a minimum interest rate to protect against losses.

Methods for Accessing Policy Cash Value

Permanent life insurance policyholders can access their accumulated cash value through several methods, each with different impacts on the policy’s future.

One method is a policy surrender, which cancels the entire life insurance policy for its net cash surrender value. The insurer terminates coverage and pays out the accumulated cash value, minus any surrender charges and outstanding loans. This permanently ends the insurance coverage, meaning no death benefit is paid to beneficiaries.

Policyholders can also take a loan against the cash value. With a policy loan, the cash value serves as collateral, and the policy itself remains in force. Loans are available for up to 90% of the policy’s cash value, and unlike traditional bank loans, they do not require a credit check or a formal approval process. While interest accrues on the loan, repayment schedules are flexible, and in some cases, repayment is not strictly required during the insured’s lifetime.

Partial withdrawals from the policy’s cash value are another option. Some permanent policies, especially universal life, allow direct withdrawals without terminating the policy. Unlike loans, withdrawals do not accrue interest. However, both policy loans and withdrawals reduce the policy’s death benefit.

Understanding the Financial and Tax Consequences

Accessing a life insurance policy’s cash value has financial and tax implications. Tax treatment varies by access method and policy characteristics.

Policy loans are not considered taxable income as long as the policy remains in force. However, if the policy lapses or is surrendered with an outstanding loan, any amount of the loan that exceeds the policy’s cost basis (premiums paid) can become taxable as ordinary income. Interest on policy loans is not tax-deductible. Withdrawals from a policy’s cash value are tax-free up to the amount of premiums paid into the policy, which is considered a return of basis. Any amount withdrawn exceeding this cost basis, representing investment gains, is subject to income tax.

Surrendering a policy can result in a taxable gain if the cash surrender value received exceeds the total premiums paid into the policy. This excess amount is taxed as ordinary income, not capital gains. For example, if $20,000 in premiums were paid and the surrender value is $30,000, the $10,000 gain would be taxable. Surrender charges may apply, particularly if the policy is canceled in its early years, reducing the net amount received. These charges can be substantial in the first 10 to 15 years of a policy.

The Modified Endowment Contract (MEC) rules, outlined in Internal Revenue Code Section 7702A, can significantly alter the tax treatment of policy loans and withdrawals. If a life insurance policy becomes a MEC—typically due to overfunding it—loans and withdrawals are taxed on a “last-in, first-out” (LIFO) basis. This means earnings are considered to be withdrawn first and are subject to income tax, and potentially a 10% penalty if the policyholder is under age 59½. This contrasts with non-MEC policies, where withdrawals are treated as tax-free return of basis first.

Accessing cash value impacts the policy’s primary purpose: the death benefit. Loans, withdrawals, and surrendering the policy all reduce or eliminate the death benefit payable to beneficiaries. An unpaid policy loan balance, plus accrued interest, is deducted from the death benefit, while withdrawals directly decrease the cash value and thus the death benefit. Surrendering the policy entirely forfeits the death benefit. This can also affect future policy performance or require higher premium payments to maintain coverage.

Steps to Access Your Policy’s Cash Value

Initiating the process to access your life insurance policy’s cash value begins with contacting the insurance company or your designated agent. This initial contact allows you to discuss your options and clarify any questions regarding your specific policy. The company can provide details about your accumulated cash value and explain the available access methods, such as surrender, loan, or withdrawal.

Following this, you will need to provide specific information to the insurer. This includes your policy number, personal identification, and a clear indication of the desired action, whether it’s a full surrender, a policy loan, or a partial withdrawal. The insurer will confirm your eligibility and outline any specific requirements relevant to your policy type and the amount you wish to access.

The next step involves completing the necessary forms provided by the insurance company. For a policy surrender, a surrender request form is required. For a loan, a policy loan application form is needed. For withdrawals, a withdrawal request form is necessary. These forms formalize your request and ensure all required details are accurately captured for processing.

Once the completed forms are submitted, the insurance company will begin processing your request. The processing time can vary, ranging from a few business days for loans and withdrawals to several weeks for a policy surrender. Funds are disbursed through a check or direct deposit, depending on your preference and the insurer’s capabilities. Upon completion of the transaction, you should receive a confirmation from the insurance company, detailing the transaction and any remaining policy values or status changes. This confirmation serves as an important record of the access event.