Can You Pull Money From Life Insurance?

Life insurance policies are primarily designed to provide a financial safety net for beneficiaries after the policyholder’s passing. However, certain types of life insurance can also offer access to funds during the policyholder’s lifetime, serving as a versatile financial tool. Understanding the mechanisms and implications of accessing these funds is important for anyone considering their life insurance options.

Life Insurance Policies with Cash Value

Life insurance policies typically fall into two main categories: term life and permanent life insurance. Term life insurance provides coverage for a specific period, such as 10, 20, or 30 years, and generally does not accumulate any cash value. If the insured outlives the term, the policy simply expires, and there are no funds to access.

Permanent life insurance, on the other hand, offers lifelong coverage and includes a savings component known as cash value. This cash value grows over time on a tax-deferred basis, meaning the earnings are not taxed as they accumulate within the policy. Common types of permanent life insurance that build cash value include whole life, universal life, indexed universal life, and variable universal life.

The cash value is distinct from the policy’s death benefit, which is the amount paid to beneficiaries upon the insured’s death. A portion of each premium payment contributes to this cash value, which can accrue interest or investment gains depending on the policy type. This accumulated cash value provides a resource that policyholders can potentially access while they are still alive.

Accessing Cash Value Through Policy Features

Policyholders with permanent life insurance have several ways to access the accumulated cash value within their policies. These methods allow for flexibility in utilizing the policy’s savings component for various financial needs. Each approach has specific mechanics that affect the policy’s cash value and death benefit.

One common method is taking a policy loan. Policyholders can borrow money directly from the insurer, using their policy’s cash value as collateral. The policy remains in force, and the loan amount is not subject to credit checks because it is secured by the policy’s value. Interest accrues on the outstanding loan balance, and any unpaid loan balance, including accrued interest, will reduce the death benefit paid to beneficiaries if the insured passes away before repayment.

Another way to access funds is through cash withdrawals from the policy’s cash value. A withdrawal directly removes a portion of the accumulated cash from the policy. Unlike a loan, a withdrawal permanently reduces the policy’s cash value. This reduction can also lead to a decrease in the policy’s death benefit.

The most significant way to access the cash value is by surrendering the policy. Surrendering a life insurance policy means terminating the contract entirely in exchange for its cash surrender value. This value is typically the accumulated cash value minus any outstanding loans, surrender charges, or other fees. When a policy is surrendered, all coverage ends, and the death benefit is no longer available to beneficiaries.

Accessing Death Benefits Early

Beyond utilizing the policy’s cash value, there are circumstances where policyholders can access a portion of their life insurance death benefit while still alive, separate from the cash value component. This is typically facilitated through features known as Accelerated Death Benefits (ADBs) or Living Benefits riders. These riders are often added to a life insurance policy, sometimes at an additional cost, and allow for early access to the death benefit under specific qualifying conditions.

Qualifying circumstances for Accelerated Death Benefits generally include being diagnosed with a terminal illness, often defined as having a life expectancy of 24 months or less. Other conditions that may qualify include chronic illness, which involves the inability to perform a certain number of daily living activities, or critical illnesses like a heart attack, stroke, or cancer. These benefits are designed to help policyholders cover significant medical expenses, long-term care costs, or other financial needs during a severe health crisis.

Accessing Accelerated Death Benefits directly reduces the eventual death benefit that will be paid to the policy’s beneficiaries. For example, if a policyholder accesses 50% of a $500,000 death benefit through an ADB, the remaining death benefit for beneficiaries would be $250,000. These benefits are distinct from the policy’s cash value and are drawn from the death benefit itself.

Financial and Policy Implications

Accessing funds from a life insurance policy carries various financial and policy implications that policyholders should carefully consider. Understanding these consequences, particularly tax considerations and the impact on the policy’s longevity, is important for informed decision-making.

The tax treatment of funds accessed from life insurance policies varies depending on the method. Policy loans are generally not considered taxable income as long as the policy remains in force and the loan is repaid. However, if the policy lapses or is surrendered with an outstanding loan, the loan amount exceeding the policy’s cost basis may become taxable. For cash withdrawals, amounts up to the policy’s “cost basis” are typically tax-free, as this is considered a return of premiums paid. Any withdrawal exceeding this cost basis, representing the policy’s earnings, is usually taxed as ordinary income.

When a policy is surrendered, any amount received exceeding the total premiums paid (cost basis) is generally taxed as ordinary income. Accelerated Death Benefits are typically excluded from gross income and are tax-free for terminally ill individuals, as defined by IRS guidelines, or for chronically ill individuals using benefits for qualified long-term care expenses. If a policy is classified as a Modified Endowment Contract (MEC) due to exceeding certain IRS premium limits, loans and withdrawals are treated differently. Earnings are taxed first and may be subject to a 10% penalty if the policyholder is under age 59½.

Beyond tax implications, accessing funds directly impacts the policy itself. Both policy loans and cash withdrawals reduce the policy’s cash value and the available death benefit for beneficiaries. If a loan is not repaid and its accrued interest grows too large, it can erode the cash value. This can potentially lead to the policy lapsing if there are insufficient funds to cover policy charges. Similarly, significant cash withdrawals can deplete the cash value, which might also lead to a policy lapse.