Can You Take Money From a Life Insurance Policy?

Life insurance policies are known for providing a financial safety net to beneficiaries after the policyholder’s death. However, certain types of life insurance offer cash value, which can be accessed during the policyholder’s lifetime. This cash value accumulates over time from a portion of premiums paid, functioning as a savings or investment element. It can grow through interest, dividends, or investment returns, offering a potential source of funds.

Policies with Cash Value

Cash value is a feature unique to permanent life insurance policies, distinguishing them from term life insurance. Permanent policies provide coverage for the policyholder’s entire life, with a portion of each premium contributing to this accumulating cash value. This accumulated amount can be used by the policyholder during their lifetime.

The main types of permanent life insurance that build cash value include:
Whole Life
Universal Life (UL)
Indexed Universal Life (IUL)
Variable Universal Life (VUL)

Whole life insurance offers a guaranteed death benefit, fixed premiums, and cash value growth at a guaranteed interest rate. Universal life policies provide flexibility with premiums and death benefits, with cash value growth often tied to an interest rate set by the insurer. Indexed universal life policies link cash value growth to a market index, such as the S&P 500, offering potential for higher returns but also increased risk. Variable universal life policies allow policyholders to invest the cash value in various sub-accounts, similar to mutual funds, carrying investment risk. Term life insurance policies are designed for a specific period and do not accumulate cash value.

Accessing Cash Value Through Loans

Taking a loan against a life insurance policy’s cash value is a common way to access funds without terminating the policy. This loan is not from a bank; you are borrowing against your own accumulated cash value, with the policy serving as collateral. There is no credit check or extensive approval process. Insurers allow policyholders to borrow up to 90% of the policy’s cash value.

Interest is charged on the loan, with rates ranging from 5% to 8%, which can be lower than rates for personal loans or credit cards. This interest accrues and can be paid periodically or added to the outstanding loan balance. While there is no strict repayment schedule, any unpaid loan balance, including accrued interest, will reduce the death benefit paid to beneficiaries.

A risk associated with policy loans is the potential for the policy to lapse. If the outstanding loan balance, plus accrued interest, exceeds the policy’s cash value, the insurance company may terminate the policy. If this occurs, the outstanding loan amount that exceeds the policy’s cost basis (total premiums paid) can become taxable income to the policyholder. It is advisable to manage the loan to prevent policy lapse.

To request a loan, the policyholder contacts their insurance company or agent. They complete a loan request form specifying the desired amount, up to the available cash value. Funds are then disbursed via direct deposit or check, with processing times ranging from a few business days to a couple of weeks. Policy loans are tax-free as long as the policy remains in force. If the policy lapses due to an outstanding loan, any gain (loan amount exceeding premiums paid) becomes taxable income.

Accessing Cash Value Through Withdrawals

A direct withdrawal is another method to access a life insurance policy’s cash value. Unlike a loan, a withdrawal is a permanent reduction of the policy’s cash value and is not repaid. The amount withdrawn directly reduces both the cash value and the policy’s death benefit dollar-for-dollar. There is no interest charged on withdrawals.

The process for requesting a withdrawal is similar to that for a loan. The policyholder contacts their insurance provider or agent and completes a withdrawal request form. They specify the amount to be withdrawn, up to the available cash value. After processing, the funds are delivered by check or direct deposit, with timelines similar to those for loans, ranging from several days to a few weeks.

The tax implications of withdrawals differ from loans. Amounts withdrawn up to the policy’s “cost basis,” which is the total amount of premiums paid into the policy, are received tax-free. However, any amount withdrawn that exceeds this cost basis is considered a gain and is subject to taxation as ordinary income. A withdrawal provides immediate access to funds, but it reduces the policy’s future value and the benefit for beneficiaries.

Policy Surrender and Its Implications

Surrendering a life insurance policy means terminating the entire insurance contract in exchange for its cash surrender value. This ends the life insurance coverage, meaning no death benefit will be paid to beneficiaries. The cash surrender value is calculated as the policy’s accumulated cash value minus any outstanding loans and applicable surrender charges. Surrender charges are fees insurers may levy for terminating a policy early, and these charges decrease over time, often disappearing after 10 to 15 years.

To surrender a policy, the policyholder contacts their insurance company and submits a formal policy surrender form. The insurer processes the request, calculates the final cash surrender value, and then issues payment via check or direct deposit. Processing times for surrender requests can vary but range from a few business days to several weeks.

The implications of surrendering a policy are clear. The primary consequence is the complete loss of life insurance coverage, meaning no financial protection is provided to beneficiaries. From a tax perspective, any amount received from the surrender that exceeds the total premiums paid into the policy (the cost basis) is considered a taxable gain. This gain is taxed as ordinary income. Surrendering a policy is an irreversible decision, ending both the coverage and the potential for future cash value growth.