When you think of life insurance, chances are the death benefit comes to mind first. But for policies with a cash value component—such as whole life, universal life, or variable universal life—there’s more beneath the surface. These policies accumulate money that you may be able to access while you’re still living. But how does that actually work? How do you receive funds from a life insurance policy?
How Distributions Work
Policies with cash value let you tap into the accumulated funds in three main ways:
Withdrawals (Distributions)
- Money comes directly out of the cash value.
- Withdrawals are generally treated on a first-in, first-out (FIFO) basis for taxes. That means you may be able to withdraw the amount you’ve paid in premiums (your “basis”) tax-free.
- Once you’ve taken out your basis, additional withdrawals may be taxable as ordinary income.
- Withdrawals reduce both the cash value and the death benefit.
Policy Loans
- Instead of withdrawing, you can borrow against your policy.
- Policy loans are generally not taxable as long as the policy stays active, but interest accrues.
- If the loan isn’t repaid, it can reduce what’s left for beneficiaries.
Surrender (Full or Partial)
- A full surrender cancels the policy, paying you the net cash value after fees and loans.
- A partial surrender reduces the policy but keeps it in force.
- Any gains above what you paid in premiums may be taxable.
Ways You May Receive Funds
- Direct Withdrawal: Funds may be sent to you by check or bank transfer.
- Loan Disbursement: If you borrow, the insurer gives you cash, much like a bank loan.
- Surrender Value: If you cancel, you may receive the policy’s net cash value.
A Numerical Example
Imagine a policy with these details:
- Death Benefit: $100,000
- Premiums Paid (Basis): $30,000
- Cash Value: $50,000
Here’s how different choices might play out:
- Withdrawal of $20,000: Comes from your $30,000 basis, so it’s generally tax-free. Death benefit may drop to about $80,000.
- Further Withdrawal of $20,000: This pulls from gains, so it may be taxable. Death benefit may drop again, possibly to $60,000.
- Loan of $20,000: Generally not taxable, but interest accrues. If unpaid, your heirs could receive $80,000 instead of $100,000.
- Full Surrender: You may receive $50,000, with $20,000 potentially subject to taxes. The policy would end.
Key Takeaways
- Withdrawals are generally tax-free until they exceed your premiums paid.
- Loans may offer tax advantages, but they can reduce your death benefit if not repaid.
- Surrender may provide access to the entire cash value, but it would also end the policy.
Final Thoughts
Cash value life insurance may serve as more than just a safety net for your loved ones—it can also be a flexible financial resource while you’re alive. But every choice has trade-offs: reduced death benefits, potential taxes, and loan interest to manage.
How might these options fit into your broader financial picture? Could they play a role in retirement income, emergency funding, or legacy planning? If you’d like to explore this in more detail, consider scheduling a complimentary conversation to see how distributions from life insurance may—or may not—align with your goals.
This information is for informational purposes only and is not intended as tax or legal advice. Please consult with your tax professional or attorney regarding your specific situation. Most life insurance policies are subject to medical underwriting, and in some cases, financial underwriting. Life insurance products contain fees, such as mortality and expense charges, and may contain restrictions, such as surrender charges. If properly structured, proceeds from life insurance are generally income tax free. Life insurance agents do not give tax or legal advice. Insurance product guarantees are backed by the financial strength and claims-paying ability of the issuing company. Product and feature availability may vary by state.
