How to Get Money Out of a Life Insurance Policy

Life insurance policies can serve as financial assets, offering ways to access funds during the policyholder’s lifetime, beyond the traditional death benefit. Understanding these options, their implications, and the processes involved is important for policyholders seeking to utilize their life insurance for immediate financial purposes.

Using Policy Cash Value

Permanent life insurance policies, such as whole life and universal life, build a cash value component over time. This cash value grows on a tax-deferred basis, meaning earnings are not taxed until withdrawn or the policy is surrendered.

One common method to access this value is through a policy loan. Policyholders can borrow against their accumulated cash value, with the policy serving as collateral. These loans do not require a credit check or a fixed repayment schedule.

Interest accrues on the outstanding loan balance, and while repayment is not mandatory during the policyholder’s lifetime, any unpaid loan balance, including accrued interest, will reduce the death benefit paid to beneficiaries. Policy loan interest rates range from 5% to 8%. Policy loans are generally tax-free as long as the policy remains in force. However, if the policy lapses with an outstanding loan, the loan amount exceeding the policy’s cost basis can become taxable income.

Alternatively, policyholders can make cash value withdrawals. A withdrawal directly reduces the policy’s cash value and, consequently, the death benefit. These withdrawals are tax-free up to the policy’s cost basis. Any amounts withdrawn that exceed this cost basis are taxed as ordinary income.

An exception applies to policies classified as Modified Endowment Contracts (MECs). If a policy becomes an MEC due to overfunding beyond IRS limits, all withdrawals are taxed on a “last-in, first-out” (LIFO) basis, meaning gains are taxed first as ordinary income before the return of premium. Additionally, withdrawals from an MEC before age 59½ may incur a 10% federal penalty tax on the taxable portion.

When deciding between a policy loan and a withdrawal, consider these factors. A loan preserves the policy’s full cash value growth potential, even as funds are accessed, and offers flexible repayment. A withdrawal, conversely, permanently reduces the cash value and death benefit. Understanding the tax implications is important, as withdrawals can trigger taxable events if they exceed the cost basis or if the policy is an MEC, while loans are generally tax-advantaged unless the policy lapses.

To initiate a policy loan or cash value withdrawal, contact the insurance company. Policyholders can reach out via phone, online portal, or mail to request the necessary forms. After completing and signing the required documentation, submit it to the insurer for processing. Funds are typically received within a few business days to a couple of weeks. The insurance company will also provide confirmation of the updated policy values and any adjustments to the death benefit.

Terminating Coverage for Cash

Fully surrendering a life insurance policy for its cash value is another way to access funds. This option provides a lump sum payment but results in the complete termination of the policy and its associated death benefit. The amount received is known as the cash surrender value.

The cash surrender value is determined by taking the policy’s accumulated cash value and subtracting any applicable surrender charges and outstanding policy loans. Surrender charges are fees imposed by the insurer for early termination of the policy, decreasing over the initial years of the policy’s life. These charges can be significant, ranging from 10% to 35% of the cash value, and phase out after 10 to 15 years.

From a tax perspective, any gain realized from surrendering a policy is subject to taxation. A gain occurs if the cash surrender value received exceeds the policy’s cost basis. This excess amount is taxed as ordinary income. For example, if a policyholder paid $30,000 in premiums and receives a cash surrender value of $45,000, the $15,000 difference is taxable. The consequence of surrendering a policy is the loss of all life insurance coverage.

The process for surrendering a policy involves contacting the insurance company. The insurer will then provide a surrender form, which must be completed, signed, and returned. After the insurance company processes the request, which can take anywhere from two to six weeks, the cash surrender value is disbursed via check or electronic transfer. The policyholder will also receive confirmation that the policy has been terminated.

Accessing Benefits Under Specific Conditions

Beyond cash value access or policy surrender, certain life insurance policies offer provisions to access funds or benefits early under specific, often health-related, circumstances.

Accelerated Death Benefits, also known as Living Benefits, are riders or provisions within a life insurance policy that allow the policyholder to receive a portion of their death benefit before death. Common triggers for these benefits include a terminal illness, where a physician certifies a limited life expectancy, 12 to 24 months. Other triggers can include chronic illness, such as the inability to perform a certain number of Activities of Daily Living (ADLs), or critical illness, like a heart attack or cancer. The advance received reduces the final death benefit paid to beneficiaries.

Accelerated death benefits are tax-free if the policyholder meets specific criteria under IRS guidelines, such as being certified as terminally ill. However, there can be taxable implications if the benefits exceed certain IRS limits for chronic illness or if the medical condition does not meet the strict definitions. To apply for accelerated death benefits, the policyholder contacts their insurance company, provides medical documentation supporting the diagnosis and prognosis, and completes the necessary claim forms. A decision on the claim can be expected within 7 to 10 business days of the insurer receiving the completed forms.

Another option is selling the life insurance policy to a third-party company through a life settlement or viatical settlement. A life settlement involves selling an existing policy for a lump sum amount that is more than the cash surrender value but less than the death benefit. The third party then assumes ownership, pays future premiums, and receives the death benefit when the insured passes away.

Life settlements are available to policyholders who are older, aged 65 or above, or those with specific health conditions, even if not terminally ill. A viatical settlement is a specific type of life settlement for policyholders who are terminally ill, with a life expectancy of 24 months or less. Eligibility for these settlements includes a policy death benefit of at least $100,000 to $250,000 and the policy being in force for a minimum number of years, two to five.

The taxation of life settlements is complex. The portion of the proceeds up to the policy’s cost basis is tax-free. Any amount received above the cost basis but up to the policy’s cash surrender value may be taxed as ordinary income. Any remaining proceeds exceeding the cash surrender value could be taxed as capital gains. Due to this complexity, consulting a tax professional is recommended.

The process for a life settlement involves working with a licensed life settlement broker who helps market the policy to potential buyers. This includes submitting policy details and medical records for evaluation. The overall process, from initial inquiry to receiving funds, can take several months, with various stages including:

Life Settlement Process

Medical record gathering
Policy valuation
Offer presentation
Legal transfer of ownership