Can You Pull Money From Your Life Insurance?

Life insurance provides financial protection to beneficiaries upon the policyholder’s death, ensuring they receive a death benefit. However, certain types of life insurance policies offer an additional feature: the ability to accumulate cash value. This accumulated value can, under specific circumstances, be accessed by the policyholder during their lifetime. Understanding which policies offer this flexibility and the various methods for accessing these funds is important for policyholders considering their options.

Life Insurance Policies with Accessible Value

Not all life insurance policies build cash value; this feature is associated with permanent life insurance options. Term life insurance provides coverage for a specific period, such as 10, 20, or 30 years, and does not accumulate accessible cash value. Its sole purpose is to provide a death benefit if the insured dies within the specified term.

Permanent life insurance policies provide coverage for the policyholder’s entire life and include a savings component that accumulates cash value over time. Whole life insurance, a type of permanent policy, builds cash value at a guaranteed rate. A portion of each premium payment contributes to this cash value, which grows on a tax-deferred basis.

Universal life (UL) insurance offers more flexibility than whole life, allowing policyholders to adjust premium payments and death benefits. Its cash value growth is tied to an interest rate set by the insurer, which can fluctuate. Variable universal life (VUL) insurance, another flexible permanent policy, allows policyholders to invest the cash value in various sub-accounts. The cash value growth in VUL policies is directly linked to the performance of these underlying investments, carrying both potential for higher returns and greater risk.

Methods for Accessing Policy Value

Policyholders with permanent life insurance can access their accumulated cash value while the policy remains active. The main methods are taking a policy loan, making a cash withdrawal, or surrendering the policy.

A policy loan involves borrowing money directly from the insurer, using the policy’s cash value as collateral. Unlike traditional bank loans, policy loans do not require a credit check or a formal repayment schedule. The policy remains in force, and the loan amount is tax-free as long as the policy remains active. Interest accrues on the outstanding loan balance, and this interest must be paid to prevent policy lapse.

Cash withdrawals involve directly taking money out of the policy’s cash value. A withdrawal reduces the policy’s cash value and can also lead to a proportional reduction in the policy’s death benefit. Unlike a loan, a withdrawal does not need to be repaid, but it diminishes the policy’s value. The amount withdrawn up to the policyholder’s cost basis (total premiums paid) is tax-free, while any amount exceeding the cost basis is subject to income tax.

Policy surrender is the method where the policyholder terminates the entire life insurance contract to receive the accumulated cash value, less any surrender charges. These charges are fees imposed by the insurer, particularly in the early years of a policy, to recover initial costs. Once a policy is surrendered, coverage ceases, and the death benefit is no longer available. The amount received, known as the cash surrender value, is subject to income tax if it exceeds the total premiums paid into the policy.

Key Considerations When Accessing Policy Value

Accessing the cash value from a life insurance policy has several financial consequences that policyholders must understand. These considerations affect both the policy’s long-term viability and the policyholder’s tax obligations. The manner in which funds are accessed directly influences the impact on the death benefit, tax implications, and the risk of policy lapse.

Taking a policy loan reduces the amount available to beneficiaries if the loan is not repaid before the insured’s death. The outstanding loan balance and accrued interest are subtracted from the death benefit. Cash withdrawals directly reduce the policy’s death benefit by the amount withdrawn. Policy surrender eliminates the death benefit entirely, as the contract is terminated.

Tax implications vary depending on the method of access. Policy loans are treated as tax-free distributions, provided the policy remains in force until the insured’s death. However, if the policy lapses or is surrendered with an outstanding loan, the loan amount exceeding the cost basis becomes taxable income. Cash withdrawals are tax-free up to the amount of premiums paid (the cost basis), but any withdrawal exceeding this basis is considered taxable income. For a policy surrender, any gain is subject to ordinary income tax.

Accessing cash value also introduces the risk of policy lapse. If a policy loan’s outstanding balance, including accrued interest, grows to exceed the policy’s cash value, the policy lapses without value. This occurs if loan interest is not paid or if the policy’s cash value diminishes due to poor investment performance in variable universal life policies. Significant cash withdrawals deplete the cash value to a point where it can no longer support the policy’s charges, leading to a lapse if additional premiums are not paid. Policyholders remain responsible for paying future premiums to maintain coverage, even after accessing cash value.