Can You Withdraw Money From Term Life Insurance?

Life insurance serves as a financial tool designed to provide security for beneficiaries after the policyholder’s passing. Term life insurance typically does not allow for withdrawals, distinguishing it from other life insurance products that accumulate accessible value. This article explores specific scenarios where funds might be received from a term policy before a death benefit payout.

Understanding Term Life Insurance Cash Value

Term life insurance provides coverage for a predetermined period, or “term,” such as 10, 20, or 30 years. If the insured individual passes away within this term, a death benefit is paid to the designated beneficiaries. It offers financial protection for a temporary need, with costs aligned to the coverage duration.

Unlike other forms of life insurance, term life policies do not build a cash value. Premiums are primarily allocated to cover the death benefit and administrative expenses. This structure means there is no savings or investment element within the policy itself.

Since term life insurance does not accumulate cash value, it offers no surrender value if canceled or expired. Policyholders receive no refund of premiums or funds upon cancellation or at term end. This design makes term life insurance more affordable than policies with cash value.

Accessing Funds from Other Life Insurance Policies

Withdrawals from life insurance policies apply to permanent life insurance, such as whole life and universal life insurance, offering lifelong coverage. These policies include a cash value component that grows over time. A portion of each premium contributes to this cash value, accumulating tax-deferred.

Whole life insurance has cash value guaranteed to grow at a set interest rate, with level premiums. Universal life offers flexibility to adjust premiums and death benefits, with cash value growth tied to an insurer’s interest rate or market index performance.

Cash value can be accessed through policy loans. Policyholders can borrow against the cash value, using it as collateral. Loans accrue interest, and if not repaid, the outstanding balance reduces the death benefit. Policy loans are not taxable income if the policy remains in force and is not surrendered with an outstanding loan exceeding the basis.

Partial withdrawals are another option. These reduce the policy’s cash value and can decrease the death benefit. Withdrawals are tax-free up to the premiums paid (cost basis). Amounts exceeding the cost basis may be subject to ordinary income tax.

Policyholders can also surrender the permanent policy for its cash surrender value. This terminates coverage entirely, and the policyholder receives the accumulated cash value, minus surrender charges or outstanding loans. If the cash surrender value exceeds total premiums paid, the excess is taxable as ordinary income. These methods of accessing funds are specific to policies with a cash value component and do not apply to term life insurance.

Specific Payout Scenarios for Term Life Insurance

While term life insurance does not offer direct withdrawals or loans from cash value, policyholders may receive funds before the death benefit payout in specific, limited circumstances. These involve advancing a portion of the death benefit or selling the policy.

One scenario involves Accelerated Death Benefit (ADB) riders. An ADB rider allows a policyholder to receive a portion of the death benefit early if diagnosed with a terminal, critical, or chronic illness, as defined by the policy’s terms. The funds received are intended to help cover medical expenses, long-term care costs, or other financial needs during a severe health crisis. The amount received through an ADB rider will reduce the final death benefit. Under federal guidelines, accelerated death benefits are not taxable income for terminally ill individuals with a life expectancy of 24 months or less. For chronically ill individuals, specific conditions regarding the use of funds, such as for qualified long-term care expenses, may apply to maintain tax-free status.

Another option is a life settlement. This involves selling a term life insurance policy to a third-party company for a lump sum of cash. The amount received from a life settlement is typically more than any cash surrender value but less than the full death benefit. In this transaction, ownership of the policy, including responsibility for future premium payments and the right to the death benefit, transfers to the purchasing company. The taxation of life settlements is tiered: proceeds up to the cost basis (premiums paid) are tax-free, amounts exceeding the basis but not the policy’s cash surrender value are taxed as ordinary income, and any proceeds above the cash surrender value are taxed as capital gains.

A viatical settlement is a specific type of life settlement that applies when the policyholder is terminally ill, often with a life expectancy of 24 months or less. Viatical settlements are treated more favorably under tax law, with proceeds often being tax-free for the terminally ill, as they are considered an advance on the tax-exempt death benefit. For chronically ill individuals, the tax-free status may be conditional on the funds being used for qualified medical or long-term care expenses.