Can You Pull Money Out of a Life Insurance Policy?

Certain types of life insurance policies include a cash value component that accumulates over time, offering a living benefit accessible during the policyholder’s lifetime. This article explores how cash value works and the ways you can potentially utilize these accumulated funds.

Understanding Policy Cash Value

Cash value in a life insurance policy refers to a portion of the premium payments that accumulates over time, separate from the death benefit. This accumulated amount grows on a tax-deferred basis, similar to certain retirement accounts, and can be considered a living benefit accessible to the policyholder during their lifetime. The growth of cash value is influenced by premium payments, policy fees, and the interest or investment returns credited to the account.

The primary types of life insurance policies that build cash value are permanent life insurance policies, including whole life, universal life, variable universal life, and indexed universal life. Whole life insurance policies offer a guaranteed cash value that grows at a fixed rate, providing predictable accumulation. The cash value in whole life is often guaranteed to reach the policy’s face amount by a certain age, typically 100, at which point the policy endows.

Universal life insurance policies provide more flexibility, allowing adjustments to premium payments and death benefits, and their cash value growth is often tied to an interest rate declared by the insurer, usually with a guaranteed minimum. Variable universal life policies allow policyholders to direct the cash value into various investment sub-accounts, such as stocks, bonds, or money market funds. This offers the potential for higher returns but also carries investment risk, as the cash value can fluctuate with market performance.

Indexed universal life policies link cash value growth to the performance of a specific market index, like the S&P 500, while often providing protection against market downturns with a minimum guaranteed interest rate. These policies typically cap the maximum annual gains. In contrast, term life insurance, which provides coverage for a specific period, does not build cash value and therefore does not offer a savings component or living benefits.

Methods for Accessing Your Policy’s Cash Value

Once a life insurance policy has accumulated sufficient cash value, policyholders have several options to access these funds. Each method operates differently and carries distinct implications for the policy’s death benefit and its continued viability. Understanding these mechanics is important before making any decisions.

Policy Loans

A common method for accessing cash value is through a policy loan. This is not a withdrawal of your money, but rather a loan taken from the insurance company, using your policy’s cash value as collateral. The loan amount can typically be up to a certain percentage of the cash value, as determined by the insurer. Policy loans accrue interest, which is generally paid back to the insurer.

Unlike traditional loans, policy loans typically do not have a fixed repayment schedule, offering flexibility to the policyholder. However, any outstanding loan balance, including accrued interest, will reduce the death benefit paid to beneficiaries if the policyholder passes away before the loan is fully repaid. If the loan and accrued interest grow to exceed the policy’s cash value, the policy can lapse, which has significant tax consequences. Insurers usually require a simple request form to initiate a policy loan.

Cash Withdrawals (or Partial Surrenders)

Another way to access cash value is through a cash withdrawal, also known as a partial surrender. This involves directly taking a portion of the accumulated cash value out of the policy. Unlike a loan, a withdrawal permanently reduces the policy’s cash value and, consequently, the death benefit proportionally.

Withdrawals are generally tax-free up to the amount of premiums paid into the policy, which is considered the cost basis. Any amount withdrawn that exceeds this cost basis is typically subject to income tax. For instance, if you paid $10,000 in premiums and your cash value is $15,000, a withdrawal of $10,000 would be tax-free, but a withdrawal of $12,000 would result in $2,000 being taxable income. This method directly depletes the policy’s internal value, which can affect its ability to sustain itself over time.

Policy Surrender

The most complete way to access your policy’s cash value is to surrender the policy entirely. When a policy is surrendered, the insurance coverage ends, and the policyholder receives the cash surrender value. This value is the accumulated cash value minus any outstanding loans, accrued interest, or surrender charges that the insurer may impose, especially in the early years of the policy.

Surrendering a policy means the death benefit coverage is terminated, and beneficiaries will receive no payout upon the policyholder’s death. This option provides full access to the policy’s accumulated funds but eliminates the primary purpose of life insurance. The process typically involves submitting a formal request to the insurance company, often requiring a signed surrender form.

Key Considerations Before Accessing Cash Value

Before making any decisions about accessing your life insurance policy’s cash value, it is important to understand the broader implications for your financial situation and the policy itself. These considerations extend beyond the immediate receipt of funds.

Tax Implications

Accessing cash value can have varied tax consequences depending on the method used. Policy loans are generally considered tax-free transactions, as they are debt rather than income. However, if a policy lapses with an outstanding loan, the loan amount that exceeds the policy’s cost basis can become taxable income. This is especially true if the policy becomes a Modified Endowment Contract (MEC), where loans and withdrawals are treated as taxable income first, up to the amount of gain, before a return of basis.

For cash withdrawals, only the portion that exceeds the policy’s cost basis (total premiums paid) is typically subject to income tax. For example, if you’ve paid $20,000 in premiums and withdraw $25,000, the $5,000 gain would be taxable. When a policy is surrendered, any amount received that is greater than the total premiums paid into the policy is considered taxable income. Consulting a tax advisor is advisable to understand the specific tax implications for your circumstances, particularly given the complexities of basis and MEC rules.

Impact on Death Benefit

Any form of accessing cash value will directly impact the death benefit available to your beneficiaries. An outstanding policy loan, including any accrued interest, will reduce the death benefit by that amount. For example, a $50,000 death benefit with a $10,000 outstanding loan would result in a $40,000 payout to beneficiaries.

Cash withdrawals permanently reduce both the cash value and the death benefit by the amount withdrawn. If you withdraw $10,000 from a policy with a $100,000 death benefit, the death benefit may decrease proportionally, depending on the policy structure. Surrendering the policy eliminates the death benefit entirely, as the insurance coverage ceases.

Risk of Policy Lapse

Utilizing your policy’s cash value can increase the risk of the policy lapsing if not managed carefully. Large withdrawals or outstanding loans that accumulate significant interest can deplete the cash value. This can leave insufficient funds to cover ongoing policy charges, such as administrative fees and the cost of insurance. If the cash value drops below the amount needed to sustain the policy, and no additional premiums are paid, the policy could terminate prematurely.

A policy lapse due to an outstanding loan can trigger a taxable event, as previously mentioned. This can leave the policyholder without coverage and with an unexpected tax liability. Maintaining sufficient cash value or continuing premium payments is important to keep the policy in force, especially if loans or withdrawals have been taken.

Future Insurability

Surrendering a life insurance policy means losing the coverage entirely. If you later decide you need life insurance, you will have to apply for a new policy. Obtaining new coverage can be more expensive or challenging due to changes in age or health. As individuals age, the cost of life insurance generally increases, and new health conditions could make it difficult or impossible to qualify for coverage at favorable rates. Therefore, the decision to surrender a policy should consider your long-term need for life insurance protection.