Can You Withdraw Money From Your Life Insurance?
Explore how to access your life insurance policy's accumulated value. Understand the methods, their implications, and the steps involved in accessing your funds.
Life insurance policies offer financial protection to beneficiaries upon the death of the insured. Certain types of policies also accumulate a “cash value” that policyholders can access during their lifetime. This cash value grows over time, providing a potential source of funds for various financial needs. Understanding how to access this value is important for policyholders.
Types of Life Insurance with Cash Value
Not all life insurance policies build cash value. This feature is exclusive to permanent life insurance, unlike term life insurance which provides coverage for a specific period without a savings component.
Whole life insurance is one type of permanent policy that offers guaranteed cash value growth at a fixed interest rate. Premiums remain level, and a portion of each payment contributes to the cash value, which grows predictably. This growth can be enhanced if the policy pays dividends, which can be reinvested to further increase the cash value and death benefit.
Universal life insurance provides flexibility, allowing policyholders to adjust premium payments and the death benefit. The cash value grows based on an interest rate, which may fluctuate but often includes a guaranteed minimum. Excess payments can build cash value faster, potentially covering future premiums.
Variable universal life (VUL) insurance allows the cash value to be invested in various subaccounts, similar to mutual funds. Growth is tied directly to investment performance, presenting both higher potential and increased risk.
Indexed universal life (IUL) links cash value growth to a market index like the S&P 500. These policies often include caps on gains and floors on losses.
Methods of Accessing Cash Value
Policyholders can access the cash value in permanent life insurance through several methods. Each method has unique mechanics and consequences.
One approach is taking a policy loan, where the cash value serves as collateral for funds borrowed from the insurer. These loans do not require a credit check or a formal repayment schedule. Interest is charged on the loan, typically 5% to 8%, and if unpaid, it accrues and is added to the loan balance.
Alternatively, policyholders can make a withdrawal from the cash value. Unlike a loan, a withdrawal directly removes money from the policy’s cash value and permanently reduces both the cash value and the death benefit. Withdrawals do not need to be repaid, but they can impact the policy’s future performance.
A third option is to fully surrender the policy, terminating coverage for the cash surrender value. The death benefit is forfeited. The policyholder receives the accumulated cash value minus any surrender charges or outstanding loans. This provides immediate access to the cash value but ends the insurance protection.
Understanding the Implications
Accessing the cash value of a life insurance policy carries important financial and policy implications. Tax treatment is a primary concern. Policy loans are not considered taxable income because they are viewed as borrowing against your own asset.
However, if the policy lapses or is surrendered with an outstanding loan, the loan amount may become taxable to the extent it exceeds the premiums paid. Interest paid on policy loans is not tax-deductible.
For withdrawals, the money received is tax-free up to the amount of premiums paid into the policy, as this is considered a return of your principal. Any amount withdrawn that exceeds the total premiums paid is considered taxable income and is taxed at ordinary income rates.
If the policy is classified as a Modified Endowment Contract (MEC), withdrawals and loans are taxed differently and may be subject to a 10% penalty if the policyholder is under age 59½.
Both policy loans and withdrawals impact the policy’s death benefit. An outstanding loan balance, including any accrued interest, will reduce the amount paid to beneficiaries upon the insured’s death. Withdrawals, being a permanent reduction of the cash value, also permanently decrease the death benefit. Excessive loans or withdrawals can lead to the policy lapsing if the cash value falls below the amount needed to cover policy charges and loan interest.
Requesting Funds from Your Policy
Initiating a request to access funds from your life insurance policy’s cash value involves contacting your insurance provider. You can reach them via phone, through their online portal, or by consulting with your financial advisor or insurance agent. The insurer will guide you through the necessary steps and provide the required documentation.
When making a request, you will need to provide your policy number and specify the desired amount you wish to borrow or withdraw. The insurance company will then inform you of the available cash value and any limits on access, which can be up to 90% of the cash value for loans. You will need to complete specific forms provided by the insurer, which can often be downloaded from their website or sent to you by mail.
Once the completed forms are submitted, the processing time can vary. Funds are disbursed either through a direct deposit to your bank account or by a mailed check. It is important to confirm the method of payment and any specific instructions for online submission or mailing completed forms to ensure a smooth transaction.