Can I Withdraw Cash Value from Life Insurance?

Provided your life insurance policy is a whole life or universal life insurance policy that has accumulated cash value, you can withdraw cash from your life insurance policy.  There are a few additional details you should understand when withdrawing cash from a life insurance policy, and we'll cover all of that in this article.

If you have a term life insurance policy, it will not have a cash value and therefore you will not be able to withdraw any cash from it.

Withdrawing Cash: How it Works and How Long will it Take?

When you own a life insurance policy with cash value, you have the option to withdraw this cash value to use for whatever purpose you deem appropriate.  The withdrawal process begins with your making a request for a withdrawal from the insurance company.  You may need to complete some paperwork in order for the life insurance company to process the withdrawal request.  This paperwork will focus on the fact that a withdrawal often leads to a reduction in outstanding death benefit of the policy.  The insurer wants to make sure you understand the effect the withdrawal will have on your death benefit coverage.

Once the life insurance company receives your request (and any required paperwork) it will process the request and issue a check for the amount requested.  Processing time is generally around a week; up to two weeks at certain times throughout the year.

In some cases, the insurer might offer to send the money electronically through an electronic funds transfer directly to your bank account.  To do this, you'll need to provide the insurance company with your bank account number, routing number, and a copy of a voided check or deposit slip.

If an EFT transfer is not an option, and you'd prefer the insurer not send you a check, you can request a wire transfer.  Wire transfers will usually incur wiring fees.

What Can you Withdraw: Understanding the Difference Between Cash Value and Surrender Value

If your life insurance policy has a surrender charge (common among universal life insurance policies) you should understand the difference between cash value and surrender value.  Essentially, the cash value is a the gross amount of cash value in the life insurance policy and the surrender value is the gross cash value minus the applicable surrender charge.

If your policy has a surrender charge, you will only be able to withdraw up to the surrender value amount of your policy.  This means you will not be able to withdraw cash value subject to the surrender charge until the surrender charge expires (on average this happens 1o years after policy issue).  The surrender charge does decrease each year, so the amount you can withdraw will go up each policy year as the surrender charge goes down.

If your policy has no surrender charge (common among whole life policies or universal life policies that reach a certain age) then the cash value and surrender value are the same, and you can withdraw the entire cash value if you wish.

It's important to note that many universal life insurance policies charge a withdrawal fee each time you make a cash withdrawal from a policy.  These fees are usually nominal, but you should know what it is before making a withdrawal.

Also, you should understand that if your life insurance is a special form of universal life insurance with a secondary guarantee, you may risk losing this potentially important feature of the policy if you make a cash withdrawal from the policy.

Is Withdrawing Cash Value from a Life Insurance Policy Taxable?

A withdrawal from a life insurance policy is not taxable provided it does not exceed your cost basis in the policy.  Once of the many tax benefits of life insurance with cash value is the ability to take a First In First Out withdrawal from the policy.  This means you can remove the already taxed dollars you used to pay the premium before you have to remove the gain from the policies interest and/or dividend earnings.

If you made other withdrawals that removed your cost basis and you make a withdrawal that does exceed the premiums you paid to the policy, this will result in a taxable distribution from the policy.  You will owe ordinary income taxes on this withdrawal.

For example, assume Mary owns a life insurance policy where she paid $50,000 in premiums and has $125,000 in cash value.  In previous years she withdrew $45,000 from the policy. She currently wants to withdraw $20,000 from the policy.  If she does this, she'll owe taxes on $15,000.  This happens before she has $5,000 remaining in cost basis, but her total withdrawal will exceed her cost basis by $15,000.  She'll end up withdrawing $15,000 of money she earned through the policy's interest or dividend earnings.

To avoid this taxable situation, Mary might choose to take a policy loan for $15,000 in conjunction with a $5,000 withdrawal.  This will keep the entire distribution she receives tax free (assuming the policy is not a Modified Endowment Contract).

When Should you Take a Withdrawal Versus a Loan?

In general, you should take withdrawals from a life insurance policy when you have cost basis to keep the withdrawal tax free and when you need money early on in life with no plans to put the money back in the policy.

Conversely, a loan is a better option when you have no remaining cost basis and/or you take money from the policy for a temporary need and you intend on putting the money back into the policy (you do this by repaying the loan).

Following this guideline will ensure the best outcome for cash accumulation of your life insurance policy.

In some cases of indexed universal life insurance, you may want to take a loan when a withdrawal appears indicated from the above rule-of-thumb.  This is the case because a loan will avoid any withdrawal fees applicable to the universal life insurance policy and because IUL policies have a unique loan feature that may make the loan virtually zero cost to you despite the loan interest.

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