To withdraw money from a life insurance policy, you need a permanent policy — whole life, universal life, or variable universal life — because those are the only kinds that build cash value you can access. If you have one, you have three basic ways to get at the money: take a partial withdrawal, borrow against the policy, or surrender it for its cash value. Each choice affects your death benefit and your tax bill differently, and the right one depends on how much you need, whether you want to keep the coverage, and how long you’ve owned the policy.
Whether Your Policy Has Cash to Withdraw
Term life insurance builds no cash value. If your policy covers you for a fixed period like 10, 20, or 30 years and has no savings component, none of the withdrawal methods below apply. Some term policies can be converted to permanent coverage, but conversion doesn’t create an instant balance.
Permanent policies set aside part of every premium in a cash account that grows on a tax-deferred basis. Whole life grows at a rate set by the insurer, sometimes with dividends on top. Universal life earns interest tied to a declared rate or a market index depending on the product.
Cash value builds slowly. In the early years most of your premium covers insurance costs and fees, so the account stays small. Meaningful balances typically take five to ten years to accumulate. If you bought the policy recently, request a current illustration from your insurer before you plan around a withdrawal — the number may be smaller than you expect.
Partial Withdrawals
A partial withdrawal lets you take some of your cash value without ending the policy. This option is most common in universal life. Whole life policies generally don’t allow partial withdrawals; the equivalent move on a whole life policy is a loan.
Insurers set their own rules. Many require a minimum withdrawal amount and cap the total at a percentage of your cash value. You don’t repay the money, which makes withdrawals simpler than loans. In exchange, your death benefit drops — usually by at least what you withdrew, and sometimes by more depending on the policy’s terms.
Taxes follow a favorable order for policies that aren’t classified as modified endowment contracts. Withdrawals come out of your cost basis first, meaning the total premiums you’ve paid. As long as you withdraw less than that total, you owe no income tax. Anything above your cost basis is taxed as ordinary income.1Office of the Law Revision Counsel. 26 U.S. Code 72 – Annuities; Certain Proceeds of Endowment and Life Insurance Contracts
Policy Loans
A policy loan lets you borrow against your cash value while keeping coverage in force. Technically, you’re borrowing from the insurer using your cash value as collateral, which is why there’s no credit check, no income verification, and no formal approval. You submit a loan request, and funds typically arrive within a few business days.
Most insurers let you borrow up to 90% of your cash value. Interest rates are set by the insurer and may be fixed or variable. Repayment terms are usually flexible; some policies let you pay on your own schedule, others require at least annual interest. If you die with a balance outstanding, the insurer subtracts it from what your beneficiaries receive.
Loans themselves aren’t taxable events as long as the policy stays in force.2Internal Revenue Service. For Senior Taxpayers 1 The trap is what happens if you stop paying interest. Unpaid interest is added to the loan balance, and that larger balance then accrues its own interest. If the loan ever grows to match your cash value, the policy lapses. At that point the IRS treats the forgiven loan as a distribution, and you owe income tax on any amount above your cost basis.1Office of the Law Revision Counsel. 26 U.S. Code 72 – Annuities; Certain Proceeds of Endowment and Life Insurance Contracts It’s a large, unexpected bill arriving at the worst possible time.
Full Surrender
Surrendering the policy cancels it in exchange for the remaining cash value. The insurer sends you a check, the death benefit disappears, and coverage ends. This makes sense only when you no longer need the insurance or the cash is worth more to you than the future payout.
Watch for surrender charges. Insurers apply these fees in the early years of the policy to recoup upfront costs. They’re steepest in year one, decline over time, and typically phase out after roughly 10 to 15 years. Surrendering a young policy can lose a large slice of the cash value to charges before you see a dime.
Any amount you receive above your cost basis is taxed as ordinary income, and the insurer will send you a Form 1099-R showing the gross proceeds and the taxable portion.2Internal Revenue Service. For Senior Taxpayers 1
Before you surrender, ask about a reduced paid-up option. This lets you stop paying premiums and convert to a smaller permanent policy with a reduced death benefit. You keep some coverage without further out-of-pocket cost and avoid the tax hit and surrender charges of a full cash-out. Not every policy offers it, but when it’s available and your real problem is the premium rather than a need for immediate cash, it’s often the better move.
Accelerated Death Benefits for Serious Illness
If you’ve been diagnosed with a terminal or chronic illness, you may be able to collect part of your death benefit while you’re still alive. Many policies, including some term policies, include an accelerated death benefit rider either built in or available as an add-on.
For terminally ill policyholders, amounts received are generally excluded from taxable income entirely under federal law.3Office of the Law Revision Counsel. 26 U.S. Code 101 – Certain Death Benefits The same exclusion applies to sales to a licensed viatical settlement provider by a terminally ill policyholder. For chronically ill policyholders, tax-free treatment is narrower and generally requires the money to go toward qualified long-term care expenses.
The percentage of the death benefit you can access and the qualifying conditions vary. Some policies require a life expectancy of 12 months or less; others use 24 months. Whatever you take early is subtracted from the death benefit your beneficiaries eventually collect. If you’re seriously ill, check for this rider before considering a loan or surrender — it’s often the most tax-efficient path.
Selling the Policy Instead
A life settlement lets you sell the policy to a third-party buyer for a lump sum. The buyer takes over premium payments and eventually collects the death benefit. Payouts typically fall between 10% and 25% of the death benefit — less than the face value, but often more than you’d net from a surrender after charges. Sellers with serious health conditions may receive higher offers because a shorter life expectancy makes the policy more valuable to the buyer.
Life settlements are generally available at age 65 and older, though younger sellers with significant health impairments can qualify. Most states regulate these transactions and require the buyer to be licensed. Proceeds are taxable: the amount above your cost basis is taxed as ordinary income, and any amount above the policy’s cash surrender value may be taxed as capital gain. Expect medical underwriting by the buyer and a process that runs several weeks.
The Modified Endowment Contract Trap
Before you take money out of any permanent policy, find out whether it’s classified as a modified endowment contract, or MEC. The IRS assigns this status when total premiums paid in the first seven years exceed the “7-pay limit” — the amount that would fully pay up the policy in seven level annual installments.4Office of the Law Revision Counsel. 26 USC 7702A – Modified Endowment Contract Defined A material change like a death benefit increase can restart the seven-year window.
MEC classification flips the tax order. Gains come out first instead of premiums, and every dollar of gain is taxed as ordinary income. Loans from a MEC are treated as taxable distributions, wiping out the main tax advantage of borrowing. If you’re under 59½, the taxable portion of a MEC distribution also carries a 10% early withdrawal penalty, the same penalty that applies to early retirement account distributions.1Office of the Law Revision Counsel. 26 U.S. Code 72 – Annuities; Certain Proceeds of Endowment and Life Insurance Contracts MEC status is permanent once assigned. If an agent ever encouraged you to overfund your policy, verify the classification before withdrawing anything.
Moving the Value Without Cashing Out: The 1035 Exchange
If your policy no longer fits your needs but has significant gains, a full surrender means paying tax on those gains. A Section 1035 exchange lets you move the cash value into a different life insurance policy, an annuity, or a long-term care insurance contract without triggering income tax.5Office of the Law Revision Counsel. 26 USC 1035 – Certain Exchanges of Insurance Policies The transfer must go directly from one insurer or policy to another; if you take the cash yourself first, the exchange doesn’t qualify.
The rules run one direction. Life insurance can move to another life policy, an annuity, or a long-term care contract, but an annuity can’t be exchanged back into life insurance.
How Withdrawals Can Affect Government Benefits
Supplemental Security Income has strict resource limits: $2,000 for an individual and $3,000 for a couple. Life insurance with a face value of $1,500 or less doesn’t count, but cash sitting in your bank account after a withdrawal does.6Social Security Administration. Supplemental Security Income (SSI) A single withdrawal can push you over and suspend benefits.
Medicaid also imposes asset limits for certain applicants, particularly for long-term care coverage. Depending on state rules, the cash value of a life insurance policy may count as a resource. If you’re receiving or applying for any means-tested benefit, talk to a benefits counselor before touching your cash value; reinstating benefits after an interruption can be difficult.
Steps Before You File the Request
Start by asking your insurer for a current policy illustration. It shows your cash value, cost basis, any outstanding loan balance, and how a withdrawal, loan, or surrender would affect the death benefit going forward. Most people never request this document, and it’s the most useful single page in the process.
Every withdrawal, loan, or surrender requires a written request. Large transactions may require a government-issued ID or a notarized signature. Processing usually runs a few business days; surrenders can take longer. The insurer must disclose how the transaction changes your cash value, death benefit, and any fees. Read those numbers before you sign.
Get a rough tax estimate before you commit. If you’re pulling out more than your cost basis, surrendering a policy with significant gains, or taking money from a MEC, the bill can be substantial. A short call with a tax professional now is cheaper than a surprise the following April.