How to Take Money Out of Life Insurance

Life insurance policies serve as a financial safety net, providing a death benefit to beneficiaries upon the insured’s passing. Beyond this primary function, certain life insurance policies can also act as a financial resource during the policyholder’s lifetime. Understanding how to access funds from a life insurance policy involves distinguishing between tapping into accumulated cash value while living and the process beneficiaries undertake to claim a death benefit. The ability to access these funds can offer financial flexibility for various needs, such as unexpected expenses or long-term planning.

Accessing Your Policy’s Cash Value

Many permanent life insurance policies include a cash value component that grows over time. This feature is found in whole life, universal life, and variable universal life policies, where a portion of each premium payment contributes to this accumulating value. The cash value can be accessed by the policyholder through loans, withdrawals, or by surrendering the policy entirely.

Policy Loans

Policy loans allow a policyholder to borrow money using their policy’s cash value as collateral. These loans typically do not require a credit check, and repayment is flexible, though interest does accrue. The amount borrowed is not considered taxable income, provided the policy remains active and the loan amount does not exceed the total premiums paid.

To initiate a policy loan, the policyholder contacts their insurance company to request a loan form. This form requires the policy number, desired loan amount, and signature. Once submitted, the insurer processes the request and disburses funds. Any outstanding loan balance will reduce the death benefit paid to beneficiaries if the loan is not repaid before the insured’s death. If the policy lapses with an outstanding loan balance exceeding the cost basis, the unpaid loan amount can become taxable income.

Withdrawals (Partial Surrenders)

Policyholders can also access a portion of their cash value through withdrawals, sometimes referred to as partial surrenders. This method allows the direct removal of funds from the policy’s cash value. Unlike loans, withdrawals reduce the cash value and the death benefit permanently.

Withdrawals are tax-free up to the amount of premiums paid into the policy, known as the cost basis. Any amount withdrawn that exceeds this cost basis is taxable income. To request a withdrawal, policyholders obtain a withdrawal request form from their insurer, providing details like the policy number and the specific amount desired. After submitting the form, the insurer processes the request, and funds are typically disbursed within a few weeks.

Full Surrender

A full surrender involves terminating the life insurance policy in exchange for its cash surrender value. This action ends the insurance coverage, and no death benefit will be paid to beneficiaries. The cash surrender value is the accumulated cash value minus any surrender charges and outstanding loans.

When surrendering a policy, any amount received that exceeds the total premiums paid into the policy (the cost basis) is taxable as ordinary income. Policyholders complete a surrender request form, supplying their policy number and signature. The insurer processes the surrender, and the policy is canceled once the payment is made. This option provides immediate access to a larger sum of money but eliminates the policy’s original purpose of providing a death benefit.

Claiming the Death Benefit as a Beneficiary

Upon the death of an insured individual, beneficiaries must initiate a claim to receive the life insurance death benefit. This process requires prompt notification to the insurance company. The death benefit is generally received by beneficiaries free of federal income tax.

To file a claim, beneficiaries gather essential documents. A certified copy of the insured’s death certificate is required. The policy number is also crucial, and if unavailable, the insurer can often locate it with the insured’s personal information. Beneficiaries then complete a claim form provided by the insurance company, which asks for details such as the insured’s full name, date of birth, date and cause of death, and the beneficiary’s contact information.

Once the completed claim form and necessary documentation are submitted, the insurance company processes the claim. Beneficiaries have several options for receiving the payout. A common method is a lump-sum payment, where the entire death benefit is disbursed at once. Other options may include installment payments over time or having the funds placed into a retained asset account. While the death benefit is generally tax-free, any interest earned on installment payments or funds held in a retained asset account is generally taxable. Most claims are processed and paid within a few weeks, though complex cases may take longer.

Early Access to the Death Benefit Under Special Conditions

In specific circumstances, a policyholder may access a portion of their life insurance policy’s death benefit while still alive, distinct from using the cash value. These options are available to individuals facing severe health challenges.

Accelerated Death Benefits (ADBs)

Accelerated Death Benefits (ADBs), also known as living benefits, are provisions or riders within a life insurance policy that allow a policyholder to receive a portion of their death benefit in advance. These benefits are triggered by specific qualifying conditions, such as a diagnosis of terminal illness (often defined as having a life expectancy of 24 months or less) or chronic illness (inability to perform daily living activities).

To be eligible, a policyholder provides medical documentation, including a physician’s certification of their condition. The insurance company provides specific forms for an ADB request, requiring detailed medical information and policyholder consent. Receiving ADBs reduces the ultimate death benefit that will be paid to beneficiaries. ADBs are not subject to federal income tax if the insured is terminally ill. For chronically ill individuals, benefits may also be tax-free if used for qualified long-term care expenses, though amounts exceeding certain daily limits can be taxable. After submitting the required forms and medical records, the insurer reviews the request and disburses the approved portion of the death benefit, which can be used for any purpose, such as medical costs or living expenses.

Viatical Settlements

A viatical settlement involves selling a life insurance policy to a third-party company for a lump-sum cash payment. This payment is less than the full death benefit but more than the policy’s cash surrender value. Viatical settlements are generally available to policyholders with a terminal or chronic illness, often with a life expectancy of two years or less.

The process involves contacting a viatical settlement provider and submitting an application with medical records. The provider assesses the policy’s value and makes an offer. If accepted, ownership of the policy is transferred to the third party, who assumes responsibility for future premium payments and receives the full death benefit upon the insured’s passing. For terminally or chronically ill individuals, the proceeds from a viatical settlement are generally tax-free under federal law, provided specific IRS requirements are met. These requirements include the policyholder’s health status and the provider’s licensing.