One major plus with a whole or permanent life insurance policy is the ability to access some or all of the account’s cash value while you’re still alive. While the main purpose of life insurance is to provide financial protection to loved ones if you pass away, you can also think of a whole life insurance policy as a cash value asset that can provide financial resources in the future, if needed.

In most cases, you can access money collected in cash value for any reason. For example, you could use the cash value to make a down payment on a new home, provide additional funding for your retirement, pay for educational costs for children or grandchildren, or cover a major medical expense for you or your spouse.

The important thing to understand is how it works when you cash out whole life insurance. In this article, we’ll cover what options you may have to access your cash value amount, repayment options, and whether it reduces your final death benefit payout to beneficiaries.

Understanding face value vs. cash value

If you’re debating cashing out a whole life insurance policy, it’s essential to understand the difference between face value and cash value.

Face value is the same as what’s often called the death benefit. If you were to pass away, the face value is the amount your beneficiary or beneficiaries would receive. In other words, if your whole life insurance policy has a face value of $50,000, that’s the amount the insurer would pay out in the event of your death.

The second component of whole life insurance is cash value. As you pay premiums over the life of your insurance policy, a portion of the money goes into an investment account and, over time, accrues cash value while also earning tax-deferred interest.

With most whole life insurance policies, the cash value amount begins to accrue after an initial 2 to 5-year period and is only accessible during your lifetime. This cash value is available to withdraw or borrow, including any accrued interest or dividends paid.

You’ll always want to talk to your financial adviser or tax professional before deciding to remove money from a life insurance policy, since all or a portion of a cash withdrawal may have significant fees or tax implications.

It’s important to keep in mind that unless you pay it back, withdrawing cash value reduces the overall face value and could impact what your beneficiaries receive when you pass away.

Options for cashing out a whole life insurance policy

There are several options for a whole life insurance cash out that allow you to take advantage of the entire cash value or a portion of the accrued balance. Each option allows you access to the cash value but has different consequences. Since fees for cashing out or surrendering your policy can cost between 10% and 40% of the cash value, consider these options carefully and always consult with a financial professional first.

1. Withdraw the entire cash value and surrender the policy

You have the option to withdraw all cash value from your policy and surrender the policy back to the insurer. When you withdraw the full cash value, you effectively terminate the entire policy and cancel any coverage going forward.

The cash surrender amount you receive will be the total of what you have paid towards the cash value to date, plus interest, less any unpaid loans or premiums. There can also be deductions that include federal income tax and surrender fees associated with the transaction.

If you plan to surrender a permanent life insurance policy, term life insurance is an affordable alternative that can provide financial protection and peace of mind for your loved ones.

2. Make a partial withdrawal

Another option is to withdraw a portion of the cash value. This won’t completely cancel your life insurance coverage as a surrender does. Instead, the cash value you remove will lower the death benefit of the original life insurance policy.

You might consider this solution if your children have achieved success in their jobs or careers, and you’re less concerned about leaving an inheritance but still want to provide your spouse with some benefits and protection.

3. Borrow against your policy with a loan

With a whole life insurance policy, you can borrow up to the full amount of your cash value. For this loan, you’re borrowing from the insurer using your cash value as collateral. Unlike typical loans that you receive from a bank or finance company, these loans:

• Don’t require a credit check and aren’t reported to the credit agencies, so they don’t appear on your credit report.
• Are not subject to underwriting requirements.
• Have very low-interest rates, usually.
• Can be outstanding for an unlimited period of time.

However, if you, as the policyholder, pass away while the loan is outstanding, the remaining balance and any associated fees are deducted from the death benefits paid to your beneficiaries.

4. Use cash value to pay for premiums

With sufficient cash value, you may have the option to quit paying premiums out of pocket. Instead, you’ll pay monthly or annual insurance premiums using the cash value available within the policy.

There are two downsides to this scenario. First, there is an immediate reduction to your overall death benefit with each premium payment. And second, there is less monetary value available for other uses, like a cash withdrawal or a policy loan.

5. Use as a living benefit (if available)

If your policy allows, use this method to withdraw money from an accelerated death benefit rider or a provision for living benefits. Should you or your spouse be diagnosed with a terminal illness or condition and require money to cover medical costs or regular living expenditures, using your cash value as living benefits can be the lifeline you need.

Like with other cash value deductions, living benefits will lower your beneficiaries’ total death benefit. You’ll need to contact your insurer to clarify if your policy enables you to use cash value as a living benefit.

Implications of cashing out a whole or universal life insurance policy

While cashing out a whole or universal life insurance policy is always an option, there may be tax implications to keep in mind. Whether or not you are required to pay taxes on cash value life insurance depends on a number of factors, including the cash value of the policy and the total value of loans attached to it.

Tax implications when you cash out a permanent life insurance policy

Depending on how it’s structured, one benefit of a permanent life insurance policy is that you can tap into its cash value without affecting the death benefit. But is cashing out whole life insurance taxable?

When you withdraw cash from a whole or universal life insurance policy, the IRS requires you to pay taxes on any amount earned from the policy through interest and investment gains. This gain is known as “above basis” earning and it refers to the amount your policy has earned beyond your premium contributions. All the cash value that you pay through premiums is not taxable.

Say, for example, that your policy has $25,000 of cash value and $22,000 has accrued through your premium payments. It means that the policy has gained $3,000 from interest and investment. You can take out the $22,000 tax-free but the $3,000 is taxable.

Tax implications when you surrender a permanent life insurance policy

When you surrender a whole or universal life insurance policy, its cost basis is not taxable but any gains on the policy are taxable. In life insurance, cost basis refers to the amount you’ve paid in premiums. Any gain on cost basis – whether from interest or investment – becomes above basis and is typically subject to tax. Generally, cashing in life insurance tax consequences occur when:

• You receive more funds than your policy’s cost basis when surrendering it. Any amount above the cost basis is taxable.
• The face value of your policy changed when the policy was still in force. This can happen if you add riders or reduce the death benefit. Usually, a portion of the money that you cash in – known as recapture amount – may be subject to tax.

Tax implications when you have an outstanding loan on a permanent policy

Policy loans and collateral assignment loans against cash value life insurance policies are not taxable as long as the policy is in force. But if you surrender the policy or if it lapses when you have an outstanding loan balance, you may need to pay taxes on a portion of the loan. Specifically, the taxable amount of the loan is anything above the policy’s cost basis.

For example, say you borrow $30,000 against a whole or universal policy. Of the amount, $20,000 is attributed to your premium payments (cost basis) and the remaining $10,000 is from policy gains (above basis). You won’t pay taxes on the loan as long as your policy is in force. But if you surrender the policy or if it lapses, you’ll owe taxes on the above basis amount – which in this example is $10,000.

Tax implications when you sell a permanent life policy

Life settlement is when you sell your life insurance policy to a third-party investor called a life settlement provider or life settlement company (if it’s an entity). The investor who buys the policy becomes the new beneficiary and starts paying the premiums. When you pass away, that investor collects the policy’s death benefit.

People often sell their life insurance policies for various reasons, including:

• When they need instant cash
• When their dependents are stable to the point that life insurance payouts won’t make a big difference in their lives
• When they can’t raise premium payments
• When they have other policies that provide sufficient coverage

The sale of a life insurance policy can either be a viatical settlement or a life settlement. A viatical settlement is when a terminally ill policyholder sells the policy to an investor. For example, a cancer patient can opt to sell a life insurance policy to raise funds for treatment. A life settlement is when a healthy policyholder sells the policy. This may be for reasons like lack of cash for premium payments.

Do you pay taxes on life insurance cash value when you sell the policy? Generally, the money that you get from a viatical sale of a life insurance policy is considered a death benefit and is not taxable. On the other hand, proceeds from a life settlement payout are usually treated as ordinary income and may be subject to tax.

Estate taxes on permanent life insurance policies

Proceeds of whole and universal life policies are not subject to estate tax, meaning that your beneficiaries won’t have to pay any taxes when they get a payout from your whole or universal life insurance policy. However, there are particular scenarios when permanent insurance payouts become taxable:

• If the policy goes into an estate: Payouts from whole or universal life insurance policies are subject to tax when they are included in a taxable estate. This typically happens when there’s no named beneficiary on the policy. Either you didn’t name a beneficiary or the beneficiary passed away and you didn’t name a new one. Whatever the case, when you pass away, the policy will go to your estate and become taxable if the total value of the estate exceeds the estate tax threshold ($13.61 million as of 2024).
• If the beneficiary decides to take the life insurance payout in installments or annuities instead of a lump sum. The money that remains in the account (after every withdrawal) accrues interest, which the IRS considers a taxable gain. The death benefit or the policy’s face value is not taxable.

Other fees associated with cashing out a permanent life insurance policy

Many whole and universal life insurance policies usually charge a surrender fee when you cash out the policy either partially or entirely. While surrender fees vary from one insurance company to another, they generally range from 10% to 20% but may be as high as 40% of the cash surrender value. You will want to read your policy thoroughly and talk to your life insurance company to know your surrender fee.

Tax advantages of withdrawing or borrowing cash value of a permanent policy

Rather than surrendering your whole or universal life insurance policy, you can withdraw some of the accumulated cash value or borrow a loan against it. In both cases, you’ll get the money tax-free as long as the amount drawn or borrowed doesn’t exceed the cost basis. This gives permanent insurance policies an edge over other asset classes like commodities, currencies, real estate and other derivatives, all of which are taxable.

As an investment, permanent life insurance allows you to build cash value without having to worry about paying taxes. Your premium payments go into two accounts: the death benefit and the cash value account. The money in the cash value account earns interest at a guaranteed rate of return. And since it is tax-free, it grows faster because you don’t owe any taxes that may lower the principal amount. The longer you pay policy premiums, the more your cash value grows.

Unlike many other investment vehicles, whole and universal life policies have fixed premiums and guaranteed returns year-on-year, making them more predictable, resistant to market volatility, and less stressful to the policyholder. These investment benefits are mere additions to the fact that you get lifelong coverage, your beneficiaries are taken care of when you pass away, and you get living benefits through loans and withdrawals.

When to cash out a whole or universal life insurance policy

Cashing out your entire whole or universal life insurance policy should always be the last option. In fact, many financial advisors recommend waiting 10 to 15 years for the policy to build cash value before considering cashing it. That said, there are situations under which surrendering a policy may make sense:

• Your financial situation is strong and your other assets are sufficient to take care of your beneficiaries in the event of your death.
• Your beneficiaries are all grown and financially stable so that a life insurance payout – especially for your current coverage amount – won’t make a big difference in their lives.
• You need urgent cash for things like medical expenses and you have exhausted all other options.
• You are unable to raise premium payments. Instead of letting the policy lapse, you can opt to surrender it.

What to consider before cashing out a life insurance policy

Cashing out a life insurance policy is a fairly simple process that has no impact on credit and doesn’t require a credit check. But before you take the leap, there are considerations and potential drawbacks to keep in mind.

Considerations for policyholders

• Limitations: If you are contemplating cashing out your whole or universal life insurance policy, you will want to start by reviewing the policy contract. Some policies have limitations for tapping into the cash value. For example, many life insurance companies don’t allow withdrawals within the first two years when you haven’t had time to build cash value.
• Reduction in cash value: Withdrawals reduce a policy’s available cash value. The cash out may be taxable if you withdraw a bigger amount than the premiums paid.
• Penalties: All policies have surrender fees that eat into the payout. This is why the cash surrender value of a policy is usually lower than its cash value.
• Reduction in death benefit: Cashing out a permanent life insurance policy may reduce its death benefit and affect the future financial security of your dependents.
• Risk of policy lapse: Usually, your life insurance company deducts premium payments from built-up cash value when you can’t make premium payments out-of-pocket. If you use up this cash value, the policy may lapse if you default on a premium payment. Getting a new policy will be harder and costlier, which may affect your ability to cover debts and ensure income continuity in the event of your death.

Impact on beneficiaries

Cashing out a whole or universal life insurance policy reduces the death benefit payable to your beneficiaries. If it’s a withdrawal, the full amount is subtracted from the death benefit. If it’s a loan, any amount you don’t pay back is subtracted from the death benefit. If you surrender the policy, your beneficiaries won’t get any pay out at all.

Since cashing out a policy puts the future financial security of your dependents in jeopardy, you may want to discuss with them whether a cash out is necessary or if there are other better alternatives for getting money.

Should you cash out your life insurance policy?

This question is important in terms of your overall financial portfolio. You’ll need to answer a few questions, including:

• Do you have adequate life insurance coverage without this policy?
• Are there less expensive life insurance options available?
• Will a whole life insurance policy cash out achieve your and your spouse’s long-term financial goals?

If you decide this is the right option for you, some financial professionals suggest giving whole life policies between 10 and 15 years to accumulate cash value before tapping into this reserve. That way, there are adequate and consequential resources available. Otherwise, the associated fees and taxes may not make a cash value payout worthwhile.

Before removing cash value, the most important thing to consider is how it will impact the policy’s death benefit. After all, that’s the primary reason for taking out a whole or universal life insurance policy. Shrinking the policy’s value might not be a good idea if your loved ones will rely on it to pay for funeral costs, settle debts, or meet basic living needs.

Whole life insurance with cash value is only one type of life insurance. Contact a licensed insurance agent at Fidelity Life to explore options and find the right policy to suit your needs and budget.