Can You Withdraw Money From Your Life Insurance?

Life insurance policies primarily provide financial protection to beneficiaries upon the insured’s death. While this core function remains consistent, certain types of policies offer an additional feature: the ability to access accumulated funds during the policyholder’s lifetime. This access can provide financial flexibility for various needs, such as unexpected expenses or supplemental income. Understanding how this feature works and its implications is important for anyone considering life insurance as part of their financial strategy.

Understanding Cash Value Life Insurance

Cash value refers to a savings component that accumulates within certain types of life insurance policies over time. This accumulated value is distinct from the death benefit, which is the amount paid to beneficiaries when the insured passes away. As premiums are paid, a portion is allocated to this cash value account, where it can grow. This growth can occur through various mechanisms, including guaranteed interest rates, market-based returns, or dividends, depending on the specific policy structure.

Not all life insurance policies include a cash value component. Term life insurance, for instance, provides coverage for a specific period, typically 10 to 30 years, and does not build cash value. These policies are generally more affordable because they offer only a death benefit for a limited duration. In contrast, permanent life insurance policies are designed to provide coverage for the insured’s entire life and typically include a cash value feature.

Common types of permanent life insurance that build cash value include:
Whole life policies, which typically offer guaranteed cash value growth at a fixed interest rate, along with fixed premiums and a guaranteed death benefit.
Universal life policies, which provide more flexibility in premium payments and death benefits, with cash value growth often tied to current interest rates.
Variable life policies, which allow policyholders to invest the cash value in various sub-accounts, similar to mutual funds, offering potential for higher returns but also greater risk.
Indexed universal life policies, which link cash value growth to a market index, often with caps on gains and floors for losses.

The cash value accumulates on a tax-deferred basis, meaning earnings are not taxed until they are accessed.

Accessing Your Policy’s Value

Policyholders with cash value life insurance have several methods available to access the accumulated value during their lifetime. These methods allow for financial flexibility, but each operates differently and has distinct procedural considerations. One common way to access funds is through a policy loan. This involves borrowing money directly from the insurer, using the policy’s cash value as collateral. Interest accrues on these loans, and while there is no strict repayment schedule, any outstanding loan balance, plus accrued interest, will reduce the death benefit paid to beneficiaries.

Another option is to take a partial withdrawal from the policy’s cash value. When a partial withdrawal is made, the cash value in the policy is directly reduced by the withdrawn amount. This reduction can also lead to a decrease in the policy’s death benefit. Unlike a loan, a withdrawal reduces the policy’s cash value permanently, and the withdrawn amount is not repaid.

A third method is to surrender the policy entirely. Policy surrender involves terminating the life insurance contract, at which point the policyholder receives the cash surrender value. This value is typically the accumulated cash value minus any surrender charges or outstanding policy loans. Surrendering a policy means giving up the death benefit entirely, and the policy ceases to exist. Surrender charges, which can be significant, are often applied during the early years of a policy to recoup the insurer’s initial costs.

Tax and Policy Implications

Accessing the cash value of a life insurance policy carries specific tax and policy implications that policyholders should understand. Policy loans are generally not considered taxable income as long as the policy remains in force. However, if the policy lapses or is surrendered with an outstanding loan, the loan amount exceeding the premiums paid into the policy can become taxable as ordinary income. This can result in an unexpected tax liability.

Partial withdrawals from a cash value policy are typically treated on a “first-in, first-out” (FIFO) basis for tax purposes. This means that withdrawals up to the amount of premiums paid into the policy, known as the cost basis, are generally received tax-free. Once the total withdrawals exceed the cost basis, any additional amounts withdrawn are considered taxable income, specifically as ordinary income. This taxation applies to the gains accumulated within the cash value.

When a policy is surrendered, the difference between the cash surrender value received and the total premiums paid (the cost basis) is taxable as ordinary income. For example, if a policyholder paid $50,000 in premiums and receives $60,000 upon surrender, the $10,000 gain would be taxable. This can represent a substantial tax burden, particularly for policies that have accumulated significant cash value.

Beyond tax considerations, accessing cash value directly impacts the policy itself. Both loans and partial withdrawals reduce the death benefit that will be paid to beneficiaries upon the insured’s death. An outstanding loan reduces the death benefit by the loan amount plus any accrued interest. Partial withdrawals directly decrease the death benefit by the amount withdrawn, as the cash value is permanently reduced.

More significantly, excessive withdrawals or unpaid loans can lead to a policy lapse. If the cash value falls below the amount needed to cover policy charges and fees, the policy may terminate, potentially without value, if the policyholder does not make additional premium payments to keep it active. This lapse would result in the loss of the death benefit and any remaining cash value.