How to Cash Out a Life Insurance Policy

Life insurance policies can serve as more than just a death benefit; certain types also accumulate cash value. This accumulated value represents a financial asset policyholders may wish to access during their lifetime. Understanding how these policies build value and the various access methods is an important part of financial planning.

Methods to Access Policy Value

Policyholders have several methods for accessing the accumulated value within a permanent life insurance policy. Each method offers unique characteristics regarding the policy’s continuation and impact on future benefits.

One method is a policy surrender, which involves canceling the life insurance coverage entirely. When surrendered, the policyholder receives the cash surrender value, which is the accumulated cash value minus any applicable fees or outstanding loans. This terminates the policy, ending the death benefit and future coverage.

Another option is a policy loan, where the policyholder borrows money from the insurer using the policy’s cash value as collateral. The policy remains in force, and the cash value continues to grow. Interest accrues on these loans, and if not repaid, the outstanding balance will reduce the death benefit paid to beneficiaries.

A third way to access value is through a partial withdrawal, allowing the policyholder to take out a portion of the cash value directly. This reduces both the policy’s cash value and its death benefit, but the policy remains active. Withdrawals are generally considered a return of premiums paid up to a certain amount.

Determining Policy Value and Eligibility

Understanding how a life insurance policy’s cash value accumulates is foundational to determining the accessible amount. Permanent life insurance policies (e.g., whole life, universal life, variable universal life) build cash value. A portion of each premium contributes to this cash value, which then grows through guaranteed interest, dividends, or investment performance, depending on the policy type. Whole life policies often have a guaranteed interest rate, while variable universal life policies invest funds in subaccounts, making growth dependent on market performance.

Cash value is influenced by premiums paid, policy fees, and policy duration. Policyholders can ascertain their current cash value by contacting their insurance provider, reviewing annual statements, or accessing online portals. These resources typically show both the cash value and the cash surrender value, which may differ due to fees.

Surrender charges are fees insurance companies may impose if a policy is surrendered or if significant withdrawals are made, particularly in early years. These charges typically decrease over time, often phasing out completely after 5 to 15 years. They can significantly reduce the net accessible cash value, with initial charges sometimes ranging from 10% to 35% of the cash value. Other administrative fees or outstanding policy loans can also impact the net amount a policyholder can access.

Eligibility to access policy value generally requires the policy to be in force and to have accumulated a sufficient cash value. It often takes several years, typically two to five years, for enough cash value to build up before a policyholder can borrow against it or make substantial withdrawals. Any existing policy loans or liens against the cash value can also limit the amount available for new access.

Steps to Access Your Policy Value

Once a policyholder determines the available cash value and chosen access method, the next step involves initiating actions with the insurance company. The process typically begins by contacting the insurer’s customer service department or a financial advisor. This initial contact allows the policyholder to confirm specific requirements and obtain necessary forms for their chosen transaction.

Forms are required for each type of request (e.g., policy surrender, loan, or partial withdrawal). These forms can usually be obtained from the insurer’s website, customer service, or by mail. Accurately complete these forms, specifying details like the exact amount requested and preferred payment method, and ensure all required signatures are provided.

Along with the completed forms, policyholders may need to submit additional documentation, such as proof of identity or the policy number, to verify their ownership and authorize the transaction. The submission method can vary by insurer, often including options like mail, online portals, or fax. After submission, the insurance company will process the request.

The processing timeframe for accessing policy value can range from a few business days to several weeks, depending on the complexity of the request and the insurer’s internal procedures. Policyholders should confirm receipt of their request and follow up if they do not receive communication or funds within the estimated timeframe. This ensures the transaction proceeds as expected and any potential delays are addressed promptly.

Tax Considerations When Accessing Policy Value

Accessing the cash value of a life insurance policy carries various tax implications that depend on the method used. For a policy surrender, any amount received that exceeds the “cost basis” of the policy is generally taxable as ordinary income. The cost basis typically refers to the total amount of premiums paid into the policy, less any dividends received or prior tax-free withdrawals. This means that while the return of your original premiums is usually tax-free, any gains above that amount are subject to income tax.

Policy loans are generally not considered taxable income as long as the life insurance policy remains in force. The loan is treated as a debt against the policy’s cash value, not a distribution of earnings. However, a policy loan can become taxable if the policy lapses or is surrendered with an outstanding loan, especially if the loan balance exceeds the policy’s cost basis. In such cases, the untaxed gain, including the loan amount, can become taxable.

Partial withdrawals from a life insurance policy are typically taxed on a “first-in, first-out” (FIFO) basis. This rule means that withdrawals are considered a return of the policyholder’s cost basis first, which is generally tax-free, until the entire basis has been recovered. Once the basis is exhausted, any subsequent withdrawals are considered taxable income, representing the policy’s accumulated earnings.

A significant exception involves Modified Endowment Contracts (MECs). A life insurance policy becomes an MEC if it is overfunded, meaning premiums paid exceed specific IRS limits within a certain period. Once classified as an MEC, the tax treatment of withdrawals and loans changes to a “last-in, first-out” (LIFO) basis, where taxable gains are distributed first. Additionally, distributions from an MEC, including loans, may be subject to a 10% federal penalty tax if the policyholder is under age 59½. An MEC designation is permanent and irreversible.

For any taxable distributions from a life insurance policy, the insurance company will typically issue IRS Form 1099-R. This form reports the gross distribution and the taxable amount to both the policyholder and the IRS. Policyholders should review this form carefully and consult a tax professional for guidance on reporting these amounts on their income tax returns.