What Kind of Life Insurance Can You Cash Out?

Life insurance primarily provides financial protection to beneficiaries upon the policyholder’s death. Beyond this, certain permanent life insurance policies offer an additional feature: cash value. Cash value is a component within a permanent policy that grows over time, separate from the death benefit. This accumulating fund can serve as a living benefit, accessible to the policyholder during their lifetime. Unlike term life insurance, permanent policies build this cash component, offering financial flexibility and a source of funds while the insured is still alive.

Life Insurance Policies with Cash Value

Several types of permanent life insurance policies accumulate cash value, each with distinct mechanisms for growth and flexibility. A portion of each premium payment contributes to this cash value, which then grows on a tax-deferred basis, meaning earnings are not taxed as they accumulate. This accumulation allows policyholders to build a financial asset that can be accessed for various needs.

Whole life insurance offers guaranteed cash value growth at a fixed interest rate determined by the insurer. Premiums for whole life policies remain fixed throughout the policy’s duration, providing predictability in financial planning. Some whole life policies may pay dividends. These dividends, while not guaranteed, can further enhance cash value, reduce premiums, or even be taken as cash. The guaranteed growth and fixed premiums make whole life a predictable option for long-term wealth accumulation.

Universal life insurance provides greater flexibility in premium payments and death benefits. The cash value in a universal life policy grows based on an interest rate set by the insurer, which can fluctuate but often includes a guaranteed minimum rate. Policyholders can adjust their premium payments within certain limits; paying more than the cost of insurance can accelerate cash value growth, while sufficient cash value may allow for reduced or skipped payments.

Variations of universal life insurance include Indexed Universal Life (IUL) and Variable Universal Life (VUL). Indexed Universal Life policies link their cash value growth to the performance of a specific stock market index, such as the S&P 500. While the cash value is not directly invested in the market, its growth is credited based on the index’s performance, subject to a cap rate that limits maximum gains and a floor rate, often 0%, that protects against market losses. This structure offers potential for higher returns than traditional universal life while providing some downside protection.

Variable Universal Life policies allow the cash value to be invested in various sub-accounts, similar to mutual funds. The growth or decline of the cash value directly reflects the performance of these chosen investments. This type carries more investment risk and potential for higher returns compared to other permanent policies, as the cash value is not guaranteed and can decrease with poor market performance. Policyholders bear the investment risk in exchange for potential greater accumulation.

Methods for Accessing Cash Value

Once a permanent life insurance policy has accumulated sufficient cash value, policyholders have several methods available to access these funds during their lifetime. Each method has distinct characteristics and implications for the policy.

Policy Loans

One common way to access cash value is through a policy loan. Policyholders can borrow against their accumulated cash value, with the policy itself serving as collateral for the loan. Loan interest rates range from 5% to 8%, which can be competitive compared to other personal loans. Unlike conventional loans, policy loans do not have a fixed repayment schedule, offering flexibility to the policyholder. However, any outstanding loan balance, including accrued interest, will reduce the death benefit paid to beneficiaries if the policyholder passes away before repayment.

Direct Withdrawals

Another method is to make a direct withdrawal from the cash value. This involves taking out a portion of the accumulated funds from the policy. Unlike a loan, a withdrawal directly and permanently reduces the policy’s cash value and, consequently, the death benefit. Withdrawals do not need to be repaid, but they diminish the future financial protection provided by the policy.

Policy Surrender

The third method is policy surrender, which involves terminating the entire life insurance contract. When a policy is surrendered, the policyholder receives the cash surrender value, which is the accumulated cash value minus any applicable surrender charges or fees. Surrendering the policy means that the death benefit coverage ceases entirely, and the policyholder no longer has life insurance protection.

Understanding the Impact of Accessing Cash Value

Accessing the cash value of a life insurance policy carries important financial and policy-related consequences that policyholders should fully understand. These impacts extend beyond the immediate benefit of receiving funds and can affect the policy’s long-term viability and the financial security it provides.

Tax Implications

The tax implications of accessing cash value vary depending on the method used. Policy loans are not considered taxable income as long as the policy remains in force. However, if the policy lapses or is surrendered with an outstanding loan, the loan amount exceeding the policy’s cost basis (total premiums paid) can become taxable income. Withdrawals are tax-free up to the amount of premiums paid into the policy, which is considered a return of principal. Any amount withdrawn that exceeds this cost basis is taxed as ordinary income. When a policy is surrendered, any gain—the amount received that exceeds the total premiums paid—is taxable as ordinary income. Consulting a tax professional is always advisable to understand specific tax liabilities.

Impact on Death Benefit

Each method of accessing cash value directly impacts the death benefit, which is the amount paid to beneficiaries. If a policy loan is taken and not repaid, the outstanding loan balance, plus any accrued interest, will be deducted from the death benefit when the insured passes away. This reduces the amount beneficiaries receive. Withdrawals permanently reduce both the cash value and the death benefit by the amount withdrawn. Unlike loans, withdrawals cannot be repaid to restore the original death benefit. Surrendering the policy eliminates the death benefit entirely, as the policy contract is terminated.

Risk to Policy’s Continued Existence

Accessing cash value can pose a risk to the policy’s continued existence. Taking out excessive loans or withdrawals can deplete the cash value to a point where it is no longer sufficient to cover the policy’s internal costs, such as administrative fees and the cost of insurance. If the remaining cash value cannot sustain these charges, and the policyholder stops making premium payments, the policy may lapse. A policy lapse means the coverage ends, and the death benefit is lost, which can have significant financial consequences for beneficiaries.