Can You Withdraw Money From a Term Life Insurance Policy?

Life insurance stands as a fundamental component of comprehensive financial planning, designed primarily to offer financial security to loved ones after an insured individual passes away. It functions as a contractual agreement where, in exchange for regular premium payments, an insurer promises to pay a specified sum, known as a death benefit, to designated beneficiaries. This financial safeguard helps families cover various expenses, including outstanding debts, living costs, and future financial needs. Different types of life insurance policies are available, each structured to address distinct financial objectives and provide varying levels of protection and features for policyholders.

Understanding Term Life Insurance

Term life insurance provides coverage for a specific period, often ranging from 10 to 30 years. This policy provides a death benefit if the insured passes away within the defined term. Premiums paid for term life insurance are allocated solely to cover the cost of this death benefit protection, along with administrative expenses.

A defining characteristic of term life insurance is its lack of a cash value component. Premiums are used exclusively for the cost of insurance coverage, so no separate fund grows within the policy. Consequently, policyholders cannot withdraw money directly from a term life insurance policy. Its financial benefit is realized only upon the insured’s death during the active term, or it expires without value if the term concludes and the insured is still living. This pure protection model makes term life insurance a straightforward and often more affordable option for temporary coverage needs.

Life Insurance Policies That Build Cash Value

In contrast to term life policies, certain types of life insurance are structured to accumulate a cash value component over the policy’s lifetime. These are broadly known as permanent life insurance policies, with common examples including whole life and universal life insurance. A portion of each premium payment made into these policies is allocated to this cash value, which grows over time. This growth is often on a tax-deferred basis, meaning earnings are not taxed as they accumulate.

The cash value represents a living benefit that policyholders can access during their lifetime, providing a financial resource beyond the death benefit. For whole life policies, the cash value typically grows at a guaranteed rate, offering predictable accumulation. Universal life policies, conversely, offer more flexibility, with cash value growth potentially tied to declared interest rates or market performance, depending on the specific product design. This accumulated cash value can become a significant asset, offering financial flexibility for various needs throughout the policyholder’s life.

Accessing Funds from Cash Value Policies

Policyholders can access the accumulated cash value from permanent life insurance policies through several distinct methods. One common approach is taking a policy loan, where the cash value serves as collateral for the borrowed amount. These loans typically do not require a credit check and often have interest rates ranging from 5% to 8%. While interest accrues on these loans, policyholders are not always required to repay them on a strict schedule; however, any outstanding loan balance, plus accrued interest, will reduce the death benefit paid to beneficiaries. Policy loans are generally not considered taxable income as long as the policy remains in force, because they are treated as a debt rather than a distribution of earnings.

Another method involves making a partial withdrawal from the cash value. This directly reduces both the policy’s cash value and its death benefit. Withdrawals are generally tax-free up to the amount of premiums paid into the policy, which is considered the cost basis. However, any amount withdrawn that exceeds the total premiums paid may be subject to income tax. If a policy is classified as a Modified Endowment Contract (MEC), loans and withdrawals are taxed differently, with earnings taxed first, and a potential 10% penalty if the policyholder is under age 59½. Policyholders may also choose to surrender the policy entirely, receiving its cash surrender value, which would terminate the coverage.