Can You Get Money From Your Life Insurance?

Life insurance serves as a financial safeguard, primarily designed to provide monetary protection to beneficiaries upon the policyholder’s death. This function helps ensure that loved ones can maintain their financial stability and cover expenses. Beyond its role as a death benefit provider, certain types of life insurance policies offer distinct avenues for accessing funds while the policyholder is still alive. These features allow individuals to leverage their policy’s value during their lifetime, providing financial flexibility for various needs. This article explores the mechanisms through which life insurance policies can offer financial access prior to death.

Life Insurance Policies with Cash Value

Life insurance policies with a cash value component accumulate a sum of money distinct from the death benefit. This cash value grows on a tax-deferred basis, meaning earnings are not taxed until withdrawn. The accumulation of cash value is a feature of permanent life insurance policies, differentiating them from term life insurance, which does not build cash value.

Whole life insurance is a type of permanent policy characterized by guaranteed cash value growth and fixed premiums. A portion of each premium payment contributes to this cash value, which grows at a predetermined rate. This predictability offers a stable financial asset that can be accessed later.

Universal life insurance provides more flexibility with adjustable premiums and a death benefit that can be modified. The cash value growth in universal life policies is tied to interest rates, offering potential for higher returns than whole life, but also subject to market fluctuations. This flexibility allows policyholders to adapt their coverage and payments to changing financial circumstances.

Variable universal life insurance allows the policyholder to invest the cash value in various sub-accounts, similar to mutual funds. This offers the potential for significant growth, but also carries higher risk, as the cash value can decrease if the investments perform poorly. Term life insurance, by contrast, provides coverage for a specific period, such as 10 or 20 years, and does not accumulate cash value, making it more affordable but without the living benefits of permanent policies.

Accessing Your Policy’s Cash Value

Policyholders can access the accumulated cash value within their permanent life insurance policies through several methods.

Policy Loan

A policy loan allows the policyholder to borrow money directly from the insurer, using the cash value as collateral. Repayment is flexible, though unpaid interest can accrue and increase the outstanding loan balance.

Cash Withdrawal

A cash withdrawal, also known as a partial surrender, involves directly removing a portion of the cash value from the policy. Unlike loans, withdrawals permanently reduce the policy’s cash value and the death benefit payable to beneficiaries. This option provides direct access to funds but diminishes the policy’s future value and protective capacity.

Full Policy Surrender

A full policy surrender involves terminating the entire life insurance contract. When a policy is surrendered, the insurer pays the policyholder the surrender value, which is the cash value minus any surrender charges or outstanding loans. Surrender charges for early termination can significantly reduce the payout, particularly in the initial years of the policy.

Understanding the Financial Consequences

Accessing a life insurance policy’s cash value carries financial and tax implications.

Policy Loans

Policy loans are generally considered tax-free distributions as long as the policy remains in force. However, if the policy lapses or is surrendered with an outstanding loan, the amount of the loan that exceeds the policy’s basis (the total premiums paid) becomes taxable as ordinary income. Interest accrues on these policy loans, and if not repaid, this interest can further reduce the policy’s cash value and the death benefit.

Withdrawals

Withdrawals from a policy’s cash value are typically tax-free up to the policy’s basis. Any amount withdrawn that exceeds the total premiums paid into the policy is generally taxed as ordinary income. This means that only the investment gains within the cash value are subject to taxation. These withdrawals directly reduce the policy’s death benefit, as the amount available to beneficiaries is lessened.

Full Surrender

When a policy is fully surrendered, any gain—calculated as cash value received minus total premiums paid—is taxed as ordinary income. This can result in a significant tax liability if the policy has accumulated substantial cash value over time. Furthermore, outstanding loans or excessive withdrawals can lead to the policy lapsing if the remaining cash value becomes insufficient to cover policy charges. A policy lapse with an outstanding loan can trigger immediate taxation of the loan amount exceeding the basis, creating an unexpected tax burden.

Accelerated Benefit Riders

Accelerated benefit riders, also known as living benefits, provide a mechanism for accessing a portion of a life insurance policy’s death benefit prior to the insured’s death. These riders are added to a policy and are not an inherent feature of cash value accumulation. They are designed to provide financial relief under specific circumstances.

Common conditions that trigger accelerated benefits include a diagnosis of terminal illness with limited life expectancy, or chronic illness requiring long-term care. Other riders may activate upon critical illness diagnoses, such as heart attack, stroke, or cancer. Upon activation, a portion of the policy’s death benefit is paid out to the policyholder, providing funds for medical expenses, care costs, or other financial needs.

The activation of an accelerated benefit rider directly reduces the death benefit paid to beneficiaries. For instance, if a policy has a $500,000 death benefit and $100,000 is accelerated, the beneficiaries would receive $400,000 upon the insured’s death. These benefits are tax-free if used for qualified medical expenses or if the insured is terminally ill, offering an advantage during severe health challenges.