How to Pull Money From Your Life Insurance

Life insurance primarily provides a death benefit to beneficiaries upon the insured’s passing. However, permanent life insurance, such as whole life and universal life, includes a cash value component that grows over time. This cash value allows policyholders to access funds during their lifetime. Unlike term life insurance, which provides coverage for a defined period and typically does not build cash value, permanent policies offer living benefits that can address various financial needs.

Accessing Your Policy’s Cash Value

Permanent life insurance policies accumulate cash value, which grows on a tax-deferred basis. Policyholders can access this cash value through several methods, offering financial flexibility.

Policy Loans

A policy loan involves borrowing money directly from the insurer, using the accumulated cash value as collateral. This is a loan against the policy’s value, not a withdrawal, and the cash value continues to accrue interest. Interest accrues on the loan, often at a lower rate than conventional loans. While there is no strict repayment schedule, any outstanding loan balance, including accrued interest, will reduce the death benefit paid to beneficiaries.

If the loan and its accrued interest exceed the policy’s cash value, the policy could lapse, potentially making the outstanding loan amount taxable. To initiate a policy loan, the policyholder contacts their insurer for the necessary forms. The insurer confirms the available loan amount, usually a percentage of the cash value, and processes the request upon receiving documentation. This process typically takes a few business days to a couple of weeks.

Partial Withdrawals

Policyholders can take partial withdrawals from their life insurance policy’s cash value. This directly reduces the policy’s cash value and, consequently, the death benefit. Withdrawals are generally tax-free up to the amount of premiums paid into the policy (cost basis). Any amount withdrawn exceeding this cost basis, representing policy gains, is typically subject to ordinary income tax.

Unlike loans, withdrawals do not need to be repaid and do not accrue interest. However, a significant withdrawal can diminish the cash value, potentially causing the policy to lapse if future premiums are insufficient to cover policy charges. To make a partial withdrawal, the policyholder submits a request form to the insurer, specifying the desired amount. The insurer processes the withdrawal, which generally takes a few days to a week.

Policy Surrender

Surrendering a life insurance policy means terminating the contract entirely in exchange for its cash surrender value. This forfeits the policy’s death benefit, as coverage ceases. The cash surrender value is the accumulated cash value minus any surrender charges and outstanding policy loans. Surrender charges, fees imposed for early termination, can be substantial in the early years of a policy.

Any gain realized from surrendering a policy—the cash surrender value received minus the total premiums paid—is subject to ordinary income tax. The process for surrendering a policy involves formal notification to the insurer, often requiring specific forms and the original policy document. After verification, the insurer disburses the net surrender value, typically within a few business days to several weeks.

Utilizing Accelerated Death Benefits

Accelerated death benefits allow policyholders to access a portion of their life insurance policy’s death benefit while they are still alive. These benefits are distinct from cash value access and are typically offered as policy riders or provisions. They are designed to provide financial relief during severe health crises.

Qualifying conditions for accelerated death benefits include diagnosis of a terminal illness with a limited life expectancy (e.g., 12-24 months). Other conditions can include chronic illness, such as the inability to perform activities of daily living, or critical illness, such as a heart attack, stroke, or cancer. These specific conditions are defined within the policy’s rider.

The benefit amount received is a portion of the policy’s death benefit, typically ranging from 25% to 95%, and is paid out either as a lump sum or in installments. The amount received directly reduces the remaining death benefit that will be paid to beneficiaries upon the insured’s passing.

Applying for accelerated death benefits requires submitting a formal request to the insurer, along with comprehensive medical documentation. This documentation must confirm the qualifying illness and prognosis, often requiring physician statements and medical records. The insurer reviews the application and medical evidence to determine eligibility and the payable benefit amount. The approval process can take several weeks, depending on the complexity of the medical review.

Important Financial and Tax Considerations

Accessing funds from a life insurance policy during one’s lifetime carries significant financial and tax implications. Policyholders should carefully consider these consequences to avoid unintended financial burdens or tax liabilities. The Internal Revenue Service (IRS) provides specific guidance on the tax treatment of life insurance proceeds and distributions.

Tax Implications

The death benefit paid to beneficiaries from a life insurance policy is generally received income tax-free. However, different methods of accessing policy funds during the insured’s lifetime have varied tax treatments.

Policy loans are generally tax-free when taken, as they are considered debt against the policy’s cash value, not income. If the policy lapses with an outstanding loan, the loan amount that exceeds the policy’s cost basis can become taxable as ordinary income, especially if the policy’s cash value is insufficient to cover the loan.

Partial withdrawals from a policy’s cash value are tax-free up to the policyholder’s cost basis, which is the total amount of premiums paid into the policy. Any amount withdrawn that exceeds this cost basis, representing the policy’s earnings or gains, is taxable as ordinary income. This “first-in, first-out” (FIFO) rule applies until the cost basis is recovered.

When a policy is surrendered, any amount received above the total premiums paid (the cost basis) is considered a taxable gain and is subject to ordinary income tax. Accelerated death benefits received due to terminal or chronic illness are generally tax-free under federal law, provided certain conditions are met, such as the funds being used for qualified long-term care expenses or the insured being certified as terminally ill.

Financial Considerations

Each method of accessing life insurance funds directly impacts the policy’s future financial performance and the death benefit. Taking a policy loan, while not immediately reducing the death benefit, will lead to a reduced payout if the loan and accrued interest are not repaid before the insured’s death. This reduction can significantly impact the financial security intended for beneficiaries.

Partial withdrawals directly reduce both the policy’s cash value and the death benefit by the amount withdrawn. This means less money will be available for future cash value growth and for beneficiaries. Depleting the cash value through withdrawals or loans also increases the risk of policy lapse if funds are insufficient to cover ongoing policy charges and premiums.

The use of accelerated death benefits directly reduces the death benefit by the amount advanced. This is a crucial consideration for beneficiaries who may be relying on the full death benefit for future financial stability. Policyholders should carefully assess their long-term financial needs and the needs of their beneficiaries before utilizing any of these options. Consulting with a qualified financial advisor or tax professional is advisable to understand the full implications and make decisions aligned with personal financial goals.