How to Withdraw Cash Value From Life Insurance Policy

Permanent life insurance policies, unlike term life insurance, accumulate a cash value component over time. This cash value grows on a tax-deferred basis, creating a financial asset within the policy. Policyholders can access this value during their lifetime for various financial needs. Understanding the methods for accessing this value is important for managing your policy.

Understanding Cash Value Access Options

Policyholders have several ways to access the cash value within their permanent life insurance policy. Each method provides advantages and implications depending on individual financial goals. Navigating these options requires understanding their mechanics.

A common method is taking a policy loan, borrowing money from the insurance company using your policy’s cash value as collateral. The policy remains in force, and the loan accrues interest at a competitive rate. There is no credit check or approval process, as the loan is secured by your policy. You can repay the loan over time, or the outstanding balance, including accrued interest, will be deducted from the death benefit.

Another option is a partial withdrawal from the cash value. This involves directly removing funds from your policy. A partial withdrawal permanently reduces both the policy’s cash value and the death benefit. The policy remains active, but with reduced coverage.

Policy surrender involves terminating the life insurance policy in exchange for its cash surrender value. The surrender value is the cash value minus any surrender charges, which can be significant, especially in early years. Electing this option ends all insurance coverage, meaning no death benefit will be paid.

Tax Considerations for Each Access Method

Accessing your life insurance policy’s cash value carries tax implications depending on the method chosen. Understanding these tax rules is important for avoiding unexpected tax liabilities. The Internal Revenue Service (IRS) treats each access method differently.

Policy loans are not considered taxable income as long as the policy remains active. This is because the IRS views the loan as an advance against your policy’s value, not income. However, if the policy lapses or is surrendered with an outstanding loan, the loan amount, up to the policy’s gain, can become taxable. The interest charged on policy loans is not tax-deductible.

Partial withdrawals are tax-free up to the amount of premiums paid into the policy, referred to as your “cost basis.” This follows the “first-in, first-out” (FIFO) rule, where withdrawals are assumed to come from non-taxable principal first. Any amount withdrawn that exceeds this cost basis is taxable income and is taxed at ordinary income rates.

When a policy is surrendered, any amount received exceeding total premiums paid is a taxable gain. This gain is taxed as ordinary income, not capital gain. For example, if you paid $50,000 in premiums and receive $65,000 upon surrender, the $15,000 difference would be taxable. Surrender charges reduce the amount you receive, but the taxable gain is still calculated based on the difference between the gross surrender value and your cost basis.

Impact on Your Life Insurance Policy

Accessing your policy’s cash value can have long-term effects on the policy, beyond tax considerations. These impacts can influence the policy’s primary purpose of providing a death benefit and its future financial viability. Understanding these consequences is important for making informed decisions.

A direct impact of policy loans and partial withdrawals is a reduction in the death benefit paid to beneficiaries. If a policy loan is not fully repaid, the outstanding loan balance, plus accrued interest, is subtracted from the death benefit. Similarly, partial withdrawals directly decrease the death benefit by the amount withdrawn, providing less financial protection.

Taking out loans or large withdrawals can increase the risk of your policy lapsing. If the cash value is depleted to a point where it can no longer cover the policy’s ongoing charges and fees, the policy could terminate. This situation can arise if the loan balance plus interest grows to exceed the cash value, potentially leaving you without coverage and facing unexpected tax liabilities on the outstanding loan.

Accessing cash value can affect the policy’s future growth and alter future premium requirements. The cash value borrowed or withdrawn is no longer available to earn interest or dividends, which can slow down the policy’s overall growth. In some cases, if the policy was designed to become “paid-up” by its cash value growth, accessing these funds might necessitate continued premium payments to maintain coverage.

Procedural Steps to Access Cash Value

Once you determine the method for accessing your life insurance policy’s cash value, the process involves several administrative steps. These actions ensure a smooth transaction and proper record-keeping with your insurance provider. Following these steps helps release funds.

Step 1: Identify Policy Details

Begin by identifying your policy details, including the policy number and the full name of your insurance provider. Having this information readily available will streamline your initial contact with the company. You may find these details on your policy documents or recent statements.

Step 2: Contact Insurer

The next step is to contact your insurance company directly. This can be done by calling customer service, visiting their website for online portals, or reaching out to your agent. Clearly state your intention to access your policy’s cash value and specify whether you intend to take a loan, make a partial withdrawal, or surrender the policy.

Step 3: Request Forms

Upon contact, request the forms required for your chosen transaction. The insurer will provide the necessary paperwork for a policy loan, partial withdrawal, or policy surrender. It is important to clarify any additional documentation or requirements the insurer may have to process your request.

Step 4: Complete and Submit Forms

Complete all sections of the required forms accurately and legibly. Ensure all necessary signatures are provided and any supporting documents are attached as requested by the insurer. Submit the completed forms according to the insurer’s instructions, which may include mailing, faxing, or uploading through an online portal.

Step 5: Processing and Disbursement

After submission, the insurance company will process your request. Processing times can vary but range from a few business days to a few weeks. Funds are disbursed via direct deposit or by check. You should also receive a confirmation notice of the transaction, detailing the amount disbursed and any remaining policy values or changes.