Can You Take Money Out of a Whole Life Insurance Policy?

Whole life insurance policies offer a unique financial component that can be accessed during the policyholder’s lifetime. This type of permanent life insurance builds a cash value, which is a savings element that grows over time. A portion of each premium payment contributes to this cash value, and the accumulated earnings typically grow on a tax-deferred basis. This growth means that taxes on the earnings are not due until the money is withdrawn or the policy is surrendered. The cash value provides a source of funds that policyholders may be able to utilize for various financial needs.

Accessing Funds Through Policy Loans

Policyholders can access funds from their whole life insurance by taking a policy loan. This is not a direct withdrawal of the cash value, but rather a loan issued by the insurance company using the policy’s accumulated cash value as collateral. Since the loan is collateralized by the policy’s own value, there are typically no credit checks or lengthy approval processes involved. The cash value itself continues to grow within the policy, unaffected by the loan, as the insurer lends its own money.

Interest accrues on the outstanding loan balance, with rates either fixed or variable. Policyholders have flexibility in repaying the loan, with options including periodic payments or letting interest be added to the balance. Repayment is optional, but recommended to maintain the policy’s full value.

If the loan, along with any accrued interest, is not repaid, it will reduce the death benefit paid to beneficiaries when the insured passes away. If the outstanding loan balance, including accumulated interest, grows to exceed the policy’s cash value, the policy could lapse. A policy lapse due to an unrepaid loan can lead to the termination of coverage and potential tax consequences for the policyholder.

Accessing Funds Through Cash Value Withdrawals

Another method is a direct cash value withdrawal, which permanently removes funds from the policy and reduces its cash value.

Consequently, a cash value withdrawal also reduces the policy’s death benefit by the amount withdrawn. This reduction impacts the financial protection intended for beneficiaries. Withdrawing funds can diminish the policy’s ability to generate future cash value growth. It may also affect any future dividend payments, as dividends are often linked to the policy’s cash value.

Accessing Funds Through Policy Surrender

Policy surrender allows access to the entire accumulated cash value by terminating the policy. The policyholder gives up the death benefit, and coverage ceases.

Upon surrender, the policyholder receives the “net cash surrender value.” This amount is calculated by taking the policy’s accumulated cash value and subtracting any outstanding policy loans, unpaid premiums, and applicable surrender charges. Surrender charges are fees that insurers may deduct if the policy is terminated within a certain period, typically during the first 10 to 20 years of the policy’s life. These charges can significantly reduce the amount received, especially in the early years.

Tax Implications of Accessing Whole Life Funds

For policy loans, funds received are generally not taxable income if the policy remains in force. However, if the policy lapses or is surrendered with an outstanding loan, the loan amount, up to the policy’s gain, can become taxable income. This occurs because the loan is no longer viewed as a debt but as a distribution.

Cash value withdrawals are taxed based on the “first-in, first-out” (FIFO) rule. Under this rule, withdrawals are first considered a return of the premiums paid into the policy, which is generally tax-free. Once the total amount withdrawn exceeds the premiums paid (the cost basis), any subsequent withdrawals are considered taxable income, as ordinary income.

When a policy is surrendered, if the net cash surrender value received is greater than the total premiums paid (the cost basis), the difference, which represents the gain, is taxable as ordinary income. The insurer will report this taxable gain to the Internal Revenue Service.

An exception applies if the policy is classified as a Modified Endowment Contract (MEC). A policy becomes a MEC if it fails the “seven-pay test” under Internal Revenue Code Section 7702A, meaning it receives more premiums than allowed during its first seven years. For MECs, loans and withdrawals are subject to “last-in, first-out” (LIFO) taxation, where earnings are considered withdrawn first and are therefore taxable. Additionally, withdrawals or loans from a MEC before age 59½ may incur a 10% federal income tax penalty, in addition to being taxed as ordinary income.

Steps to Request Funds from Your Policy

The first step to access funds is to contact the insurance company directly or your insurance agent or financial advisor. They serve as the primary point of contact for all policy-related transactions.

The insurer will require policy information to verify your identity and policy details. They may also inquire about the purpose of the funds, though this generally does not affect approval. Once verified, the company will provide the necessary forms.

Depending on the type of access desired, you will need to complete specific forms, such as a loan request form, a cash withdrawal form, or a policy surrender form. These forms ask for precise details, including the exact amount of funds requested, the preferred method of disbursement (e.g., direct deposit or check), and the policyholder’s signature.

After completing the forms, they must be submitted to the insurance company through their designated channels, which may include mail, fax, or an online portal. The processing time for fund disbursements can vary, but policyholders can expect the funds to be processed and disbursed within a period ranging from a few business days to several weeks. It is advisable to confirm the expected processing time with the insurer when submitting the request.