How to Withdraw Money From a Life Insurance Policy

Life insurance policies offer more than a death benefit; certain types also accumulate cash value. This cash value is a living benefit, representing a portion of premiums paid into the policy that grows over time. Policyholders might access this cash value for various financial needs, such as managing unexpected expenses, supplementing retirement income, or funding significant purchases. Unlike term life insurance, which provides coverage for a specific period and does not build cash value, permanent life insurance policies like whole life or universal life include this savings feature. This allows the policy to serve as a financial tool during the insured’s lifetime.

Primary Methods for Accessing Cash Value

Policyholders have options for accessing the cash value within their permanent life insurance policies. The three primary ways to tap into this value are through policy loans, partial withdrawals, or by surrendering the policy entirely.

Policy loans allow you to borrow money directly against your policy’s cash value. The cash value serves as collateral for the loan, meaning no credit check is required. Interest accrues on the outstanding loan balance, and the insurance company determines the interest rate, which can be fixed or variable. If the loan and any accrued interest are not repaid before the insured’s death, the outstanding balance will reduce the death benefit paid to beneficiaries.

Partial withdrawals involve taking funds directly from the policy’s cash value. Unlike a loan, a withdrawal permanently reduces the policy’s cash value and, consequently, the death benefit amount. This option does not require repayment. The amount withdrawn will diminish funds available for future use or for beneficiaries. Consider the current cash value and any applicable withdrawal limits.

Surrendering the policy means terminating the life insurance coverage entirely in exchange for its cash surrender value. This value is the accumulated cash value minus any surrender charges and outstanding policy loans. Surrender charges are fees imposed by the insurance company, especially if the policy is surrendered within its early years. Surrendering the policy eliminates the death benefit, and the policyholder receives the net surrender value directly.

To evaluate these options, policyholders should review their policy’s current cash value statement. For loans, understand the specific loan interest rate outlined in the policy documents. If considering a surrender, identify any applicable surrender charges, which can significantly reduce the payout, especially in the initial years.

Navigating Tax Implications

Understanding the tax implications of accessing life insurance cash value is important, as tax treatment varies significantly depending on the method chosen. The growth of cash value within a life insurance policy is tax-deferred, meaning taxes are not due on earnings until funds are accessed. The cost basis of a policy, which is the total amount of premiums paid into it, plays a role in determining what portion of a withdrawal or surrender is taxable.

Policy loans are considered tax-free transactions. This is because a loan is treated as borrowing against your own asset rather than a distribution of gains. However, if the policy lapses with an outstanding loan balance, and the loan amount exceeds the policy’s cost basis, the excess amount becomes taxable income. This situation converts the tax-free loan into a taxable distribution.

Partial withdrawals are tax-free up to the policy’s cost basis. This is due to the “first-in, first-out” (FIFO) rule, which assumes the money withdrawn first is a return of your premium payments. Any amount withdrawn that exceeds the cost basis, representing accumulated earnings, is taxable income. Keeping track of total premiums paid is important for assessing potential tax liability on withdrawals.

Surrendering a policy results in any gain being taxable. A gain occurs if the cash surrender value received exceeds the policy’s cost basis. This excess amount is considered ordinary income and is fully taxable in the year the policy is surrendered. The entire surrender value, less any outstanding loans, is paid out, and the tax liability is calculated on the difference between this amount and the premiums paid.

A Modified Endowment Contract (MEC) designation alters the tax treatment of cash value access. A policy becomes a MEC if it is overfunded, meaning premiums paid exceed certain IRS limits within the first seven years. Once classified as a MEC, all distributions, including loans and withdrawals, are subject to the “last-in, first-out” (LIFO) rule for tax purposes. This means earnings are considered distributed first, making them taxable income immediately, and withdrawals or loans may also be subject to a 10% penalty if taken before age 59½.

Steps for Requesting Funds

After evaluating methods for accessing cash value and understanding financial and tax implications, the next step is initiating the request for funds. The process begins by contacting the insurance company that issued the policy. This can be done by reaching out to your insurance agent, calling customer service, or accessing their online policyholder portal.

The insurance company will guide you on obtaining the necessary request forms. These forms are specific to the type of transaction you wish to perform, such as a “Policy Loan Request Form,” “Partial Withdrawal Form,” or “Policy Surrender Form.” Ensure you receive the correct form for your intended action to avoid delays. These forms will require your policy number and personal identifying information.

Along with the completed form, you will need to provide supporting documentation. This includes proof of identity, such as a copy of a driver’s license or state ID, to verify policy ownership. For direct deposit of funds, a voided check or bank account information is required. Preparing all necessary documentation beforehand can streamline the process.

After completing the form and gathering any required documents, the submission process can vary by insurer. Common submission methods include mailing documents to the company’s designated address, faxing them, or uploading them securely through an online portal. Some insurers may also allow electronic signatures, simplifying submission.

Upon submission, the insurance company will process your request, which takes a few business days to a few weeks, depending on complexity and processing times. You should receive confirmation once the transaction is complete, followed by the disbursement of funds according to your chosen method. Future policy statements will reflect the updated cash value and adjusted death benefit amount, providing a record of the transaction’s impact.