Can You Take Money Out of Your Life Insurance?

While term life insurance solely offers a death benefit for a specific period, permanent life insurance policies can accumulate a cash value during the insured’s lifetime. This accumulated value can be accessed by the policyholder, offering a financial resource for various needs beyond the traditional death benefit.

Life Insurance Policies with Cash Value

Cash value in life insurance represents a savings component within certain permanent policies. A portion of each premium payment is allocated to this cash value, which grows over time, often on a tax-deferred basis. This accumulation is distinct from the policy’s death benefit, which is paid to beneficiaries upon the insured’s death. The cash value can be accessed during the policyholder’s lifetime.

Several types of permanent life insurance policies build cash value. Whole life insurance offers a guaranteed death benefit and fixed premiums. Its cash value grows at a guaranteed interest rate, providing predictable accumulation. Universal life insurance provides more flexibility, allowing adjustments to premium payments and the death benefit. Its cash value growth can fluctuate, though some policies offer a guaranteed minimum interest rate.

Variable universal life insurance allows policyholders to invest in sub-accounts, similar to mutual funds, for greater control over cash value growth. This offers potential for higher returns but carries increased risk, as cash value and death benefit can decrease with poor investment performance. Indexed universal life insurance ties cash value growth to a market index, such as the S&P 500, often with caps on gains and floors on losses. The specific rate and method of cash value accumulation depend on the policy type and insurer’s terms.

Ways to Access Your Policy’s Cash Value

Policyholders with permanent life insurance have several methods to access their accumulated cash value while the policy remains active. Each method impacts the policy’s remaining value and death benefit.

One common method is taking a policy loan, where the insurer lends money using the policy’s cash value as collateral. Policy loans offer flexible repayment terms, with interest accruing on the balance. If the loan and accrued interest are not repaid, the outstanding amount will be subtracted from the death benefit. If the loan balance, including interest, exceeds the policy’s cash value, the policy could lapse, resulting in a loss of coverage.

Another option is a policy withdrawal, also known as a partial surrender. This involves directly taking a portion of the cash value. Unlike a loan, a withdrawal permanently reduces the policy’s cash value and the death benefit. Large withdrawals can diminish the cash value, potentially leading to a policy lapse if premiums are not increased or resumed. Some policies may impose waiting periods or penalties for early withdrawals.

The third method is a full policy surrender, which terminates the life insurance coverage entirely. The policyholder receives the cash surrender value, which is the accumulated cash value minus any outstanding loans, unpaid charges, or surrender fees. Surrender charges are common, especially if the policy is terminated early, and can significantly reduce the amount received. Surrendering the policy permanently ends the death benefit.

Tax Implications of Accessing Life Insurance Funds

Accessing funds from a life insurance policy’s cash value can have various tax implications, depending on the method and policy characteristics.

Policy loans are generally not taxable income, provided the policy remains in force. The Internal Revenue Service (IRS) views these funds as an advance against the cash value. However, if a policy lapses or is surrendered with an outstanding loan, the loan amount may become taxable income if it exceeds the policy’s cost basis. The cost basis represents total premiums paid, minus prior tax-free distributions. If the policy is a Modified Endowment Contract (MEC), loans can be taxable to the extent of policy gains, potentially incurring a 10% penalty if the policyholder is under age 59½.

Policy withdrawals are typically treated on a “first-in, first-out” (FIFO) basis for tax purposes. Withdrawals are first considered a tax-free return of premiums paid. Once total withdrawals exceed the policy’s cost basis, any additional amounts are considered taxable income, taxed at ordinary income rates. This gain represents the interest and earnings accumulated within the cash value.

When a policy is fully surrendered, the cash surrender value received is compared to the policy’s cost basis. If the cash surrender value exceeds the cost basis, the difference is a taxable gain, taxed as ordinary income. For instance, if a policyholder paid $50,000 in premiums (cost basis) and receives $70,000 upon surrender, the $20,000 difference would be taxable. If the surrender value is less than or equal to the premiums paid, there is typically no taxable gain. Outstanding loans at surrender could also trigger tax consequences if the loan amount, combined with other distributions, exceeds the cost basis.

Process for Accessing Policy Funds

Accessing funds from a life insurance policy’s cash value involves several administrative steps. Policyholders generally begin by contacting their insurance company directly, either through customer service or their assigned agent.

During this initial contact, the policyholder provides their policy number and the specific amount of funds they wish to access. They also specify the desired method: a policy loan, partial withdrawal, or full surrender. The insurer will then guide them through the necessary documentation, typically a specific request form obtained from the insurer’s website or mailed directly.

Required supporting documents may include identification verification and bank account information for direct deposit. Once all forms are completed and supporting documents gathered, they must be submitted to the insurance company. Submission methods vary, including mailing original forms, online portal, fax, or email. After submission, the insurer processes the request, which typically takes a few business days to several weeks. Funds are then disbursed, usually via check or electronic transfer.