How to Get Money From a Life Insurance Policy

Life insurance policies are financial contracts primarily designed to provide a death benefit to designated beneficiaries upon the insured’s passing. However, certain policies and circumstances allow funds to be accessed during the insured’s lifetime. Understanding these mechanisms helps policyholders and beneficiaries navigate the financial aspects of life insurance.

Claiming the Death Benefit

Initiating a life insurance claim requires beneficiaries to notify the insurance company of the insured’s death. The first step involves locating policy documents, which contain the insurer’s name and policy number. If unavailable, beneficiaries can contact the insurer directly with the insured’s full name, date of birth, and date of death, or seek assistance from the insured’s financial advisor or estate planning attorney.

Insurance companies require specific documentation to process a death claim. A certified copy of the death certificate is required to verify the policyholder’s passing; obtaining multiple certified copies from the local vital records office or funeral home is advisable. The insurer’s claim form must also be completed, requesting details like the beneficiary’s information, policy number, and date of death. Accurate completion is important, as errors can delay the process.

The completed claim form and supporting documents can be submitted through various methods, including mail, online portals, or in-person submission. Once submitted, the insurance company reviews the claim to ensure the policy is valid and the death is covered. This verification process typically takes 14 to 60 days, though some claims may be processed in as little as 7 to 10 business days.

Beneficiaries have several options for receiving the death benefit once the claim is approved. The most common method is a lump-sum payment, disbursed in a single payment via check, wire transfer, or direct deposit. Another option involves the insurer holding funds in an interest-bearing retained asset account, which functions like a checking account allowing beneficiaries to withdraw funds while earning interest. Alternatively, beneficiaries might choose to receive the benefit as an annuity, providing regular payments over a specified period or for life. Interest earned on retained asset accounts or annuities may be subject to taxation.

Accessing Policy Value During the Insured’s Lifetime

Policyholders with permanent life insurance, such as whole life or universal life, can access the accumulated cash value during their lifetime. These methods offer financial flexibility but directly impact the policy’s value and death benefit.

One common method is cash value withdrawals, where a policyholder can take out a portion of the policy’s cash value. This directly reduces the policy’s cash value and, consequently, the death benefit. Withdrawals allow access to funds without terminating the policy, but they permanently decrease its overall value.

Policy loans offer another way to access cash value. Policyholders can borrow funds directly from the insurer, using the policy’s cash value as collateral. These loans accrue interest, and if not repaid, the outstanding loan amount will reduce the death benefit. Unlike withdrawals, policy loans are not taxed as long as the policy remains in force and does not lapse with an outstanding loan.

Policy surrender involves terminating the life insurance policy in exchange for its cash surrender value. This ends the insurance coverage and its death benefit. The cash surrender value is the accumulated cash value minus any surrender charges or outstanding loans, representing the amount the policyholder receives upon cancellation.

Accelerated death benefits, also known as living benefits, are riders or provisions allowing policyholders to access a portion of their death benefit under specific qualifying conditions. These conditions often include a terminal illness with a limited life expectancy, chronic illness requiring long-term care, or critical illness. Receiving accelerated benefits reduces the policy’s death benefit.

Life settlements and viatical settlements involve selling a life insurance policy to a third party for a cash sum greater than the cash surrender value but less than the death benefit. In a life settlement, the policyholder is typically healthy or has a moderately reduced life expectancy. A viatical settlement applies to terminally or chronically ill policyholders. In both cases, the policy’s ownership and the right to the death benefit transfer to the third-party buyer, who then assumes responsibility for future premium payments.

Understanding Tax Implications

Understanding the tax implications of accessing life insurance funds is important, as treatment varies significantly depending on how the money is obtained. Death benefits paid to beneficiaries are generally received income tax-free. However, any interest earned on death benefit proceeds, such as interest accumulated in a retained asset account, is typically taxable.

When accessing a policy’s cash value during the insured’s lifetime, different tax rules apply. Cash value withdrawals are generally tax-free up to the amount of premiums paid into the policy (the cost basis). Any amount withdrawn exceeding this cost basis is typically taxed as ordinary income.

Policy loans are generally not considered taxable income, as they are treated as borrowing against an asset rather than a distribution. However, if a policy lapses or is surrendered with an outstanding loan, the loan amount exceeding the policy’s cost basis may become taxable as ordinary income.

Upon policy surrender, if the cash surrender value received exceeds the total premiums paid (the cost basis), the gain is taxable as ordinary income. The insurance company may issue a Form 1099-R if the cash surrender value exceeds the premiums paid, indicating the taxable portion.

Accelerated death benefits are generally tax-free if the insured is certified as terminally ill (typically with a life expectancy of 24 months or less) or chronically ill. For chronically ill individuals, proceeds are tax-free if used for qualified long-term care expenses, though limits may apply. If the insured does not meet the IRS’s definition of terminally or chronically ill, benefits may be considered taxable income.

Life settlements and viatical settlements have distinct tax treatments. Viatical settlements for terminally or chronically ill individuals are generally tax-free, provided certain conditions are met, such as the provider being licensed and life expectancy criteria satisfied. Life settlements, where the policyholder is not terminally ill, can have more complex tax implications. Proceeds up to the cost basis (premiums paid) are generally tax-free. Amounts received above the cost basis up to the cash surrender value are typically taxed as ordinary income, while any remaining proceeds above the cash surrender value are taxed as capital gains. Consulting a qualified tax advisor is advisable for personalized guidance.