How to Take Money Out of a Life Insurance Policy

A life insurance policy can provide financial security for beneficiaries after the policyholder’s passing, but certain types also offer a living benefit through accumulated cash value. This cash value represents a portion of the premiums paid that grows over time within the policy. It functions as a savings component, offering a resource the policyholder can access during their lifetime for various financial needs. This feature distinguishes these policies from term life insurance, which solely provides a death benefit without a cash accumulation component.

Policies with Cash Value

Cash value accumulation is a characteristic of permanent life insurance policies, designed to provide coverage for an individual’s entire life. Whole life, universal life, and variable life insurance are the primary types that build cash value. Each type accumulates value differently, offering varying degrees of guarantees and investment potential.

Whole life insurance is a straightforward form of permanent coverage with a guaranteed death benefit and a fixed premium. A portion of each premium payment contributes to the cash value, which grows at a guaranteed interest rate.

Universal life insurance offers more flexibility, allowing policyholders to adjust premiums and death benefits within certain limits. Its cash value growth is often tied to an interest rate set by the insurer, though some policies may have a guaranteed minimum.

Variable universal life insurance provides even greater flexibility, allowing the policyholder to invest the cash value in various sub-accounts, such as stocks and bonds. This offers the potential for higher returns, but also carries investment risk, meaning the cash value can fluctuate with market performance. In contrast, term life insurance policies do not build cash value because they provide coverage for a specific period, typically 10 to 30 years, and expire without value if the insured outlives the term.

Ways to Access Policy Value

Policyholders have several methods to access the accumulated cash value within their permanent life insurance policies. These options include taking policy loans, making cash withdrawals, or surrendering the policy entirely. Each approach has distinct implications for the policy’s death benefit and continued coverage.

Policy loans allow policyholders to borrow money from the insurer, using the policy’s cash value as collateral. The loan amount is not a withdrawal of the cash value itself; rather, the insurer lends the money, and the cash value continues to grow. Interest accrues on the loan, and any outstanding loan balance, including accrued interest, will reduce the death benefit paid to beneficiaries if the policyholder passes away before repayment. Policyholders can borrow up to 90% of their policy’s cash value, and there is no credit check involved since the policy serves as collateral.

Cash withdrawals involve directly taking a portion of the accumulated cash value from the policy. Unlike a loan, a withdrawal permanently reduces the policy’s cash value and, consequently, the death benefit. If the withdrawal amount exceeds the premiums paid into the policy, the excess may be subject to income tax. Withdrawals can also impact future premiums or potentially cause the policy to lapse if the remaining cash value is insufficient to cover ongoing costs.

Policy surrender involves terminating the life insurance policy in exchange for its cash surrender value. The cash surrender value is typically the policy’s accumulated cash value minus any surrender charges and outstanding loans or fees. Surrender charges are often higher in the early years of a policy.

Tax Considerations for Accessing Funds

Accessing funds from a life insurance policy’s cash value involves specific tax rules that vary depending on the method of access and the policy’s classification. The Internal Revenue Service (IRS) generally provides favorable tax treatment for life insurance policies, but exceptions apply.

The “cost basis” in a life insurance policy represents the total amount of premiums paid into the policy. When making withdrawals from a non-Modified Endowment Contract (MEC) policy, withdrawals are generally considered a return of principal (cost basis) first, until the total withdrawn exceeds the cost basis. Any amount withdrawn beyond the cost basis is considered taxable income.

Policy loans from a non-MEC policy are generally not considered taxable income because they are viewed as a loan against collateral, not a distribution of policy earnings. However, if the policy lapses or is surrendered with an outstanding loan, the loan amount that exceeds the cost basis may become taxable.

Upon policy surrender, any gain—the amount received that exceeds the total premiums paid into the policy (cost basis)—is subject to income tax. For example, if a policyholder paid $50,000 in premiums and receives $60,000 upon surrender, the $10,000 gain would be taxable.

A “Modified Endowment Contract” (MEC) is a cash-value life insurance policy that has lost some of its tax advantages because the cumulative premiums paid have exceeded specific federal tax law limits. If a policy becomes an MEC, loans and withdrawals are subject to less favorable tax rules, similar to annuities. Distributions from an MEC are taxed on an “interest first” basis. Additionally, distributions taken before age 59½ from an MEC may be subject to a 10% federal income tax penalty. While the death benefit of an MEC remains tax-free, the living benefits are taxed more aggressively.

Process for Accessing Funds

Initiating the process to access funds from a life insurance policy’s cash value involves direct communication with the insurance company. The first step is to contact the insurer to determine the specific options available under their policy and request the necessary paperwork.

The insurance company will then provide the relevant forms, such as a policy loan request form, cash withdrawal form, or surrender request form. These forms typically require specific information to process the transaction, including the policy number, the desired amount to be accessed, and the policyholder’s signature.

Once the forms are filled out, they can be submitted to the insurance company through various methods. Common submission options include mailing the physical forms, uploading them through the insurer’s secure online portal, or, in some cases, submitting them in person at a local office. After submission, the insurance company will begin processing the request. Processing times can vary but typically range from a few business days to a few weeks. The policyholder should receive a confirmation once the request is processed, followed by the disbursement of funds according to the chosen method, such as direct deposit or a mailed check.