Can You Withdraw Money From Life Insurance?

Certain life insurance policies allow policyholders to access accumulated funds during their lifetime. This capability comes from a cash value component that grows over time. Understanding how this cash value works and the various methods available for accessing it is important for financial planning. Accessing these funds involves considerations that can impact the policy’s future benefits and financial standing. This article explores policies that build cash value, ways to access these funds, and the financial implications.

Policies That Allow Access

Life insurance policies are categorized into term life and permanent life insurance. Term life insurance provides coverage for a specific period, such as 10, 20, or 30 years, and typically does not build cash value. Its purpose is to offer a death benefit if the insured passes away within the specified term.

Permanent life insurance policies are designed to provide coverage for an individual’s entire life. These policies include a cash value component, which is a portion of the premium payments that accumulates over time. This cash value grows on a tax-deferred basis, meaning earnings are not taxed until withdrawn.

Among permanent life insurance options, whole life insurance is common, with cash value growing at a fixed or guaranteed interest rate. Universal life insurance offers flexibility in premium payments and death benefits, with cash value growth often tied to interest rates or market performance, typically with a guaranteed minimum rate. Variable universal life insurance allows policyholders to invest cash value in sub-accounts, offering potential for higher returns but also greater risk. Indexed universal life insurance links cash value growth to a market index, providing potential for growth while often including a floor to protect against market downturns.

Methods for Accessing Cash Value

Policyholders with permanent life insurance can access their cash value through several methods. Each option provides financial flexibility but carries specific consequences for the policy. Understanding these methods is important for making informed decisions.

One common method is taking a policy loan, using the policy’s cash value as collateral. This is not a traditional bank loan; it does not require a credit check or income verification. The loan amount is typically limited, often up to 90% of the cash value. Interest accrues on the outstanding balance. Any unpaid loan balance, including accrued interest, will reduce the death benefit paid to beneficiaries. If the loan plus interest exceeds the cash value, the policy can lapse, terminating coverage.

Another way to access funds is through partial withdrawals from the cash value. Unlike a loan, a withdrawal permanently reduces both the cash value and the policy’s death benefit. Funds withdrawn do not need to be repaid, but the reduction in cash value can affect the policy’s future growth. Some policies may have limits on withdrawals or fees.

A third method is surrendering the policy, which means canceling coverage in exchange for its cash surrender value. The cash surrender value is the accumulated cash value minus any surrender charges and outstanding loans. Surrender charges are fees imposed by the insurer, especially if the policy is canceled within the first several years, and can vary. Surrendering the policy terminates the death benefit, meaning beneficiaries receive no payout upon the insured’s death.

Financial Considerations of Accessing Funds

Accessing a life insurance policy’s cash value carries several financial implications that policyholders should carefully consider. These considerations impact the policy’s long-term viability, its benefits, and potential tax obligations.

Tax implications are a significant factor when accessing cash value. Policy loans are not treated as taxable income as long as the policy remains in force. However, if the policy lapses with an outstanding loan, the loan amount exceeding the premiums paid (cost basis) may become taxable. For withdrawals, funds are typically tax-free up to the policyholder’s cost basis, which is the total amount of premiums paid into the policy. Any amount withdrawn beyond this cost basis, representing policy earnings, is subject to ordinary income tax.

A critical consideration is the classification of a policy as a Modified Endowment Contract (MEC). A life insurance policy becomes an MEC if premiums paid exceed federal tax law limits, specifically failing the “seven-pay test.” Once designated an MEC, this classification is permanent. Distributions from an MEC, including loans and withdrawals, are taxed differently; they are treated as coming from taxable gains first and may be subject to a 10% penalty if the policyholder is under age 59½.

Accessing cash value also directly impacts the policy’s death benefit. Any outstanding policy loans, plus accrued interest, will be deducted from the death benefit paid to beneficiaries. Partial withdrawals also permanently reduce the death benefit. This reduction can diminish the financial protection intended for beneficiaries.

Substantial loans or withdrawals can increase the risk of policy lapse. If the cash value is depleted and sufficient premiums are not paid, the policy may terminate. A lapse can result in loss of coverage and potential tax liabilities on any gains if the loan balance exceeds the cost basis. Accessing cash value can also affect the policy’s future performance, as funds are no longer available to earn interest or dividends, potentially slowing future cash value growth.