How to Cash Out a Whole Life Insurance Policy

Whole life insurance policies provide lifelong coverage and include a cash value component. This cash value grows over time, offering policyholders a financial resource. This guide clarifies how policyholders can access the cash value within their policies.

Understanding Whole Life Policy Cash Value

Whole life insurance cash value is a portion of premiums allocated to a savings component, distinguishing it from term life insurance. As premiums are paid, a segment contributes to this account, while other portions cover the death benefit and administrative expenses.

Cash value accumulates steadily at a guaranteed fixed interest rate. Some policies, especially from mutual companies, may also distribute dividends. These dividends can enhance cash value, reduce premiums, or be taken as cash. This growth is tax-deferred, meaning interest earnings are not taxed annually while funds remain in the policy.

Policyholders can find their current cash value through annual statements, by contacting their insurer’s customer service or agent, or via online portals.

Surrender charges can affect accessible cash value, especially in early years. This fee is imposed if a policy is canceled prematurely, helping the insurer recover initial expenses like sales commissions. Charges typically range from 10% to 35% of the cash value, declining over five to fifteen years. The “surrender value” is the net amount received after deducting these charges and any outstanding policy loans.

Methods for Accessing Cash Value

Policyholders have several ways to access accumulated cash value, each with distinct implications for the policy. The choice depends on financial needs and whether to maintain or terminate coverage. Understanding each option is important.

Full Surrender

Full surrender terminates the policy and its death benefit. The policyholder receives the net cash surrender value, which is the accumulated cash value minus surrender charges and outstanding loans. This closes the policy, ending future premium obligations.

While providing immediate liquidity, full surrender means losing life insurance coverage and its death benefit. Surrender charges can significantly impact the amount received, especially in early years. Confirm the exact surrender value with the insurer.

Partial Withdrawal

Partial withdrawal allows access to a portion of cash value without terminating the policy. This keeps coverage in force, though the withdrawn amount reduces the policy’s cash value and death benefit.

Withdrawals are generally tax-free up to the premiums paid (cost basis). Amounts exceeding this basis may be subject to ordinary income taxes. Unlike a loan, partial withdrawals do not require repayment, and the death benefit reduction is permanent unless additional premiums are paid.

Policy Loan

Policy loans use cash value as collateral, keeping the policy in force. Issued by the insurer, these loans typically don’t require credit checks or formal applications, offering flexible repayment.

Interest accrues on the loan balance. Unpaid loan balances, including interest, reduce the death benefit. If the loan balance exceeds the cash value, the policy can lapse, terminating coverage and potentially incurring tax consequences.

Reduced Paid-Up Option

The reduced paid-up option is a non-forfeiture benefit. It allows policyholders to stop paying premiums while maintaining a smaller, fully paid-up life insurance policy. The existing cash value purchases this new policy, which requires no further payments and continues to accumulate cash value and earn dividends.

This option suits those who want to stop premiums but retain permanent life insurance. The death benefit is reduced, but coverage remains for life without additional cost. It differs from surrender by preserving a death benefit.

Tax Considerations

Accessing whole life policy cash value has tax implications depending on the method and if the policy is a Modified Endowment Contract (MEC). Understanding these rules is crucial for financial decisions.

Cost basis is central to tax liability. For life insurance, it’s the total premiums paid, reduced by prior tax-free distributions. Funds received up to this cost basis are generally a tax-free return of principal.

Upon full surrender, any amount exceeding the policy’s cost basis is generally taxable as ordinary income. This gain is reported to the IRS, often via Form 1099-R. The surrender value (cash value minus charges) is used for this calculation.

For partial withdrawals, the Internal Revenue Service (IRS) applies a “first-in, first-out” (FIFO) rule under Internal Revenue Code Section 72. Withdrawals are tax-free returns of cost basis until recovered. Amounts exceeding the cost basis are typically taxed as ordinary income.

Policy loans are generally not taxable income while the policy remains in force, as cash value acts as collateral. However, if the policy lapses or is surrendered with an outstanding loan, the loan amount representing a gain can become taxable income.

A policy becomes a Modified Endowment Contract (MEC) if it fails the “7-pay test” under Internal Revenue Code Section 7702A, which limits premiums paid in the first seven years. MEC status is irreversible.

MEC tax rules differ from non-MEC policies. Distributions (withdrawals and loans) from a MEC are taxed on a “last-in, first-out” (LIFO) basis, meaning investment gains are taxed first as ordinary income. Distributions before age 59½ are generally subject to an additional 10% federal penalty tax on the taxable portion, unless an exception applies.

Initiating a Transaction

After evaluating cash value, selecting an access method, and considering tax implications, the next step is initiating the transaction. This administrative process requires direct communication with the insurance provider to ensure smooth execution.

First, contact the insurance company directly via customer service, a financial advisor, the issuing agent, or online portals to manage accounts and initiate requests.

Clearly state your intention to access cash value and specify the method (surrender, withdrawal, or loan). The insurer will provide required forms, such as a “Surrender Request Form,” “Policy Loan Application,” or “Withdrawal Request Form.”

Complete forms accurately. The insurer may require supporting documentation like government ID, the original policy, and a voided check for direct deposit. Ensure all fields are filled and signatures executed to prevent delays.

Submit completed forms and documentation to the insurance company via mail, secure online portal, or fax. The insurer will confirm receipt and begin processing.

Processing times vary. Funds are typically disbursed within 14 to 60 days after approval, either by check or direct deposit. The insurer will send a confirmation with disbursement details and remaining policy status.