Can You Take Money Out of a Life Insurance Policy?

Life insurance serves as a financial safeguard, providing a death benefit to beneficiaries upon the passing of the insured individual. While many understand this primary function, certain types of life insurance policies offer an additional feature: the accumulation of cash value. This accumulated value can become a valuable asset accessible to the policyholder during their lifetime, offering a financial resource beyond the death benefit.

Understanding Life Insurance Cash Value

Cash value in a life insurance policy represents a savings component that accumulates over time within certain permanent life insurance contracts. A portion of each premium payment contributes to this cash value, which then grows on a tax-deferred basis. This accumulation can occur through guaranteed interest rates, market-based returns, or dividends, depending on the specific policy type.

A fundamental distinction exists between life insurance policies that build cash value and those that do not. Term life insurance provides coverage for a specific period, such as 10, 20, or 30 years, and does not accumulate cash value. In contrast, permanent life insurance policies are designed to provide lifelong coverage and inherently include a cash value component.

Several types of permanent life insurance policies build cash value, each with unique characteristics. Whole life insurance, for instance, offers a guaranteed death benefit, fixed premiums, and a cash value that grows at a guaranteed interest rate. Policyholders might also receive dividends, which can further enhance the cash value.

Universal life (UL) insurance provides more flexibility, allowing adjustments to premium payments and death benefits within certain limits. Its cash value grows based on interest rates declared by the insurer, with a guaranteed minimum rate, and can be influenced by market performance. Variable universal life (VUL) insurance offers even greater control, enabling policyholders to invest the cash value in various sub-accounts, similar to mutual funds, which exposes the cash value to market fluctuations and potential for higher returns or losses.

Accessing Cash Value Through Policy Loans and Withdrawals

Policyholders can access the accumulated cash value in their permanent life insurance policies through two primary methods while the policy remains active: taking a policy loan or making a partial withdrawal. Each method has distinct mechanics and tax implications that impact the policy’s future.

Policy loans allow policyholders to borrow money using their policy’s cash value as collateral. These loans do not require a credit check, and the loan amount can be up to 90% of the accumulated cash value. While there is no mandatory repayment schedule, interest accrues on the loan balance.

An outstanding loan, including any accrued interest, will reduce the death benefit paid to beneficiaries if the insured passes away before the loan is fully repaid. Policy loans are not considered taxable income while the policy remains in force. However, if the policy lapses or is surrendered with an outstanding loan, the loan amount exceeding the premiums paid into the policy can become taxable as ordinary income.

Partial withdrawals involve directly taking out a portion of the cash value from the policy. This action reduces both the policy’s cash value and the death benefit by the amount withdrawn. Withdrawals are tax-free up to the amount of premiums paid into the policy, which is considered a return of the policyholder’s cost basis.

Any amount withdrawn that exceeds this cost basis, representing the policy’s earnings or gains, is taxable as ordinary income. While policy loans are debt against the policy, withdrawals permanently remove funds and reduce the policy’s value.

Accessing Cash Value Through Policy Surrender

Policy surrender involves terminating the contract entirely to access its value. When a policyholder surrenders a permanent life insurance policy, they receive the “cash surrender value.” This amount is calculated by taking the accumulated cash value and subtracting any outstanding policy loans and applicable surrender charges.

Surrendering a policy results in the complete forfeiture of the death benefit; insurance coverage ceases, and beneficiaries will no longer receive a payout. Surrender charges are fees imposed by the insurance company for early termination of the policy. These charges decrease over time and may disappear entirely after a certain number of years, ranging from 10 to 15 years from the policy’s inception.

From a tax perspective, surrendering a life insurance policy can lead to taxable income. Any gain realized from the surrender, which is the cash surrender value received minus the total premiums paid into the policy (the cost basis), is taxable as ordinary income. For example, if a policyholder paid $50,000 in premiums and receives $65,000 as the cash surrender value, the $15,000 gain would be subject to ordinary income tax. Policyholders should consult with a tax professional to understand the specific tax implications based on their individual circumstances and policy details.