How to Pull Money Out of a Life Insurance Policy

Life insurance policies provide a financial safety net to beneficiaries, but also offer various avenues for accessing funds during the policyholder’s lifetime. These options can provide financial flexibility for a range of needs, from unexpected expenses to long-term care, or even for supplementing retirement income. Understanding these mechanisms allows policyholders to leverage their insurance as a living asset, adapting to changing financial circumstances.

Accessing Policy Cash Value

Permanent life insurance policies, such as whole life or universal life, accumulate a cash value over time, which can be accessed while the policy remains active. This cash value grows on a tax-deferred basis, offering a valuable resource that policyholders can tap into through loans or partial withdrawals. The availability and terms of these options depend on the specific policy type and its accumulated value.

Policy Loans

A policy loan allows you to borrow money directly from your life insurance company, using your policy’s cash value as collateral. This method offers a flexible way to access funds without undergoing a credit check, as the loan is secured by your own policy. Interest accrues on the outstanding loan balance, typically ranging from 5% to 8%, which is generally lower than rates for personal loans or credit cards. While there is no strict repayment schedule, any unpaid loan balance, including accrued interest, will reduce the death benefit paid to beneficiaries if the policyholder passes away before repayment.

To initiate a policy loan, you typically contact your insurance provider to confirm your policy’s available cash value and request the necessary application forms. These forms will require your policy number, identification details, and the desired loan amount, often limited to up to 90% of the policy’s cash value. After submitting the completed form, processing times can vary, but funds are usually disbursed directly to the policyholder via check or electronic transfer. Loan proceeds are generally not considered taxable income, as they are viewed as an advance against the policy’s cash value. However, if the policy lapses or is surrendered with an outstanding loan, the loan amount exceeding the premiums paid (cost basis) can become taxable.

Partial Withdrawals

Partial withdrawals, also known as partial surrenders, allow you to take out a portion of your policy’s cash value. Unlike a loan, a partial withdrawal permanently reduces both the policy’s cash value and its death benefit. This option is often considered tax-free up to the amount of premiums paid into the policy, which is referred to as the cost basis. If the withdrawal amount exceeds the cost basis, the excess portion may be considered taxable income.

To request a partial withdrawal, you contact your insurance company to obtain the specific withdrawal request form. You will need to provide your policy number, identification, and the exact amount you wish to withdraw. Once the completed form is submitted, the insurer processes the request, within a reasonable timeframe, and disburses the funds. While partial withdrawals offer direct access to cash, they diminish the policy’s overall value and the amount available for beneficiaries.

Selling or Surrendering Your Policy

When a life insurance policy no longer serves its original purpose, or when immediate financial needs arise, policyholders can choose methods that involve terminating the coverage. These options, while providing a lump sum, result in the loss of the policy’s death benefit and may have significant tax implications.

Full Policy Surrender

Surrendering a life insurance policy means terminating the insurance coverage entirely in exchange for its cash surrender value. This value is calculated by taking the policy’s accumulated cash value and subtracting any applicable surrender charges and outstanding loans. Surrender charges, which can range from 10% to 35% of the cash value, decrease over time and may disappear after 10-15 years of holding the policy.

The process for a full surrender involves contacting your insurance provider, completing a specific surrender form, and providing proof of identity. The payout is received as a lump sum. From a tax perspective, any amount received from the surrender that exceeds the total premiums paid into the policy (your cost basis) is considered a taxable gain and is taxed as ordinary income. For example, if you paid $20,000 in premiums and receive $30,000 upon surrender, the $10,000 gain would be taxable.

Viatical and Life Settlements

Viatical and life settlements involve selling your life insurance policy to a third-party company for a lump sum payment. This payment is higher than the policy’s cash surrender value but less than the full death benefit. The third-party buyer then becomes the new owner and beneficiary of the policy, responsible for paying future premiums and receiving the death benefit when the insured passes away.

The distinction between the two depends on the insured’s health status. A viatical settlement is specifically for individuals who are terminally ill, generally with a life expectancy of 24 months or less. The proceeds from a viatical settlement are typically tax-free at the federal level. Conversely, a life settlement is for individuals who are chronically ill or elderly, but not necessarily terminally ill.

Life settlement proceeds are generally subject to taxation. The amount received up to the cost basis is tax-free. Amounts between the cost basis and the cash surrender value are taxed as ordinary income, and any remaining proceeds are taxed as capital gains. The process typically involves contacting a settlement provider or broker. An application including medical and policy details is submitted, followed by a medical review, and then an offer is received.

Receiving Benefits Under Special Circumstances

Certain life insurance policies include provisions that allow policyholders to access a portion of their death benefit while still alive, under specific health-related conditions. These “living benefits” are designed to provide financial relief during challenging times without fully terminating the policy.

Accelerated Death Benefits (ADBs) are riders or provisions that enable a policyholder to receive a portion of their life insurance policy’s death benefit before their passing. These benefits are usually triggered by qualifying conditions such as terminal illness (often defined as having a life expectancy of 24 months or less), chronic illness, or critical illness. Some policies may also allow access if the policyholder requires long-term care or is confined to a nursing home. The amount received as an ADB reduces the remaining death benefit that will be paid to beneficiaries.

To claim ADBs, the policyholder or their representative must notify the insurer and submit the required medical documentation, such as a physician’s certification of the qualifying condition. The insurer will review the evidence and, upon approval, disburse a portion of the death benefit, which can range from 25% to 100% depending on the policy and insurer. These funds can be used for any purpose, including medical expenses, hospice care, or daily living costs. Generally, accelerated death benefits are not subject to federal income tax if the insured is terminally ill. However, there can be tax implications if the payments exceed certain IRS limits for chronic illness, if interest is earned on the payout, or if the policy does not meet specific federal definitions for terminal or chronic illness.

Claiming Death Benefits

The primary purpose of a life insurance policy is to provide financial security to designated beneficiaries after the insured’s death. Claiming these death benefits ensures the policy’s intended support reaches those it was meant to protect.

Beneficiaries are individuals or entities named by the policyholder to receive the death benefit. Policyholders should maintain accurate and up-to-date beneficiary designations to avoid delays or disputes in the payout process. Upon the policyholder’s death, the named beneficiaries are responsible for initiating the claim.

To claim the death benefit, beneficiaries typically need to contact the insurance company, often providing the policy number and a certified copy of the death certificate. The insurer will then provide claim forms that need to be completed and submitted along with any other requested documentation, such as proof of the beneficiary’s identity.

Once the claim is approved, beneficiaries usually have several options for receiving the payout, including a lump sum, which is the most common, or installment payments over a specified period. Other options include:
An interest-only option
Fixed-period installments
Fixed-amount installments
A life income option
A retained asset account where the insurer holds the funds and allows check-writing privileges

Most life insurance claims are processed and paid within 14 to 60 days after submission of all required documentation, though complex cases or those within the policy’s contestability period (typically the first two years) may take longer. The death benefit payout itself is generally not subject to income tax for the beneficiary.