Can You Take Out Money From Life Insurance?

Life insurance provides a financial safeguard, offering a death benefit to beneficiaries upon the passing of the insured. Certain types of life insurance policies also accumulate a cash value over time, which can become an accessible resource for policyholders during their lifetime. This article explores how cash value accumulates and the various methods policyholders can use to access it.

Cash Value Life Insurance Explained

Cash value represents a component of certain permanent life insurance policies that grows over time, distinct from the death benefit. Unlike term life insurance, which provides coverage for a specific period without building cash value, policies such as whole life, universal life, and variable universal life include this feature. A portion of each premium payment made by the policyholder is allocated to this cash value component, contributing to its growth.

The accumulation of cash value occurs through various mechanisms depending on the policy type. For instance, whole life policies offer a guaranteed interest rate on the cash value, ensuring predictable growth. Universal life policies provide more flexibility, with cash value growth often tied to an interest rate declared by the insurer, which can fluctuate. Variable universal life policies link cash value growth to the performance of underlying investment sub-accounts, introducing both potential for higher returns and greater risk.

Ways to Access Your Policy’s Value

Policyholders have several methods to access the value within their permanent life insurance policies, each with distinct implications for the policy’s death benefit and potential tax consequences. Understanding these options is important to avoid unintended outcomes. The available methods include taking a policy loan, making a cash withdrawal, surrendering the policy, or utilizing accelerated death benefits under specific circumstances.

Policy Loans

A policy loan allows a policyholder to borrow money directly from the insurance company, using the policy’s cash value as collateral. The loan amount is limited to a percentage of the accumulated cash value, often up to 90% or 95% of the available amount. Interest accrues on the outstanding loan balance, and the insurance company will specify the applicable interest rate, which can be fixed or variable.

While repayment of a policy loan is not strictly mandated on a fixed schedule, any outstanding loan balance, including accrued interest, will reduce the death benefit paid to beneficiaries. If the loan and interest grow to exceed the policy’s cash value, the policy could lapse, potentially triggering a taxable event. Policy loans are tax-free as long as the policy remains in force and does not lapse with an outstanding loan that exceeds the policy’s cost basis.

Cash Withdrawals

Policyholders can also choose to make a direct cash withdrawal from their policy’s accumulated cash value. Unlike a loan, a withdrawal permanently reduces the cash value and, consequently, the death benefit amount available to beneficiaries. The withdrawn funds are removed from the policy and no longer participate in its future growth.

Withdrawals are generally considered tax-free up to the amount of premiums paid into the policy, which is known as the “cost basis.” Any amounts withdrawn that exceed this cost basis are taxed as ordinary income, following the “last-in, first-out” (LIFO) accounting rule for tax purposes. This means that earnings are considered withdrawn before the return of premiums.

Policy Surrender

Surrendering a life insurance policy means terminating the coverage entirely in exchange for its cash surrender value. This action ends all benefits associated with the policy, including the death benefit, and the policyholder no longer has life insurance coverage. The cash surrender value is the accumulated cash value less any surrender charges imposed by the insurer, which are often higher in the early years of a policy.

Upon surrendering a policy, any amount received by the policyholder that exceeds the policy’s cost basis is considered taxable income. This gain is taxed as ordinary income in the year the policy is surrendered. Before surrendering a policy, it is advisable to consider the loss of coverage and the potential tax liability.

Accelerated Death Benefits (Living Benefits)

Accelerated death benefits, also known as living benefits, provide an option to access a portion of the death benefit while the insured is still alive, under specific qualifying circumstances. These benefits are available if the policyholder is diagnosed with a terminal, chronic, or critical illness as defined by the policy. The specific conditions and the percentage of the death benefit that can be accelerated vary by policy and insurer.

Accessing accelerated death benefits reduces the remaining death benefit that will be paid to beneficiaries upon the insured’s death. The funds received from accelerated death benefits are generally tax-free, provided certain conditions are met. These provisions offer financial relief during challenging health circumstances without incurring immediate tax burdens.

Requesting Funds From Your Policy

After understanding the methods of accessing funds, the next step involves initiating the request with the insurance company. This process requires direct communication with the insurer or your financial professional. Most insurers offer multiple channels for submitting requests.

The initial step involves contacting the insurance company’s customer service department via phone or through their secure online portal. You will need to provide your policy number, specify the desired access method (e.g., loan or withdrawal), and the amount. The insurer will then provide the necessary forms to process your request. Forms can be downloaded from the company’s website or mailed.

Once completed and signed, forms must be submitted to the insurance company. Submission methods include mailing, faxing, or uploading through a secure online portal. Processing times vary, typically from a few business days to a couple of weeks, depending on the request’s complexity and insurer procedures. Funds are commonly disbursed via direct deposit or check. Review the transaction confirmation from the insurer to ensure accuracy.