Can I Cash Out Or Borrow Against My Life Insurance Policy

Yes, you can cash out life insurance if you have a permanent policy with accumulated cash value, withdrawing up to your basis tax-free or taking a loan against the balance. Term policies offer no cash access. The money you put in is yours to reclaim. Any gain beyond that gets taxed as ordinary income if withdrawn. This includes dividends or growth your cash value earned. The real question isn’t just “can I,” but “what will it cost my beneficiaries and my tax bill if I do?” The answer depends entirely on whether you own term or permanent coverage. It also depends on whether you choose a withdrawal, a loan, or a full cash-out.

The difference between term and permanent cash out life insurance access

Only whole, universal, and variable life policies build usable cash value. Term policies offer zero withdrawal options. Term insurance is pure protection. You pay a premium for a death benefit. If you die during the term, your beneficiaries collect. If you live past the term, the coverage ends with no residual value. That’s why the phrase “outlive my term life insurance policy” strikes fear into policyholders who assumed they’d get something back. Permanent policies split your premium into three buckets. These are the cost of insurance, administrative fees, and a cash reserve that grows tax-deferred. After two to five years, that reserve becomes a real asset you can access. Whole life sets a fixed premium and guaranteed growth. Universal life lets you adjust premiums and death benefits. Variable life invests your cash value in sub-accounts tied to the stock market. All three build a cash-out value you can borrow against or withdraw from. A term policy is a rental contract. You pay for coverage. When the lease ends, you walk away with nothing.

Withdrawals versus loans and the tax trap

Withdrawing beyond your cost basis triggers income tax. Policy loans avoid immediate taxation but risk a lapse with a massive tax bill. Your cost basis is the total premiums you’ve paid in. The IRS treats that as your original investment. Taking out up to that amount is tax-free. If your cash value has grown, any withdrawal above your basis is considered taxable gain. You’ll owe ordinary income tax on it. For example, say you paid a $50,000 basis into a policy. Your cash value is $80,000. You can withdraw $50,000 tax-free. The next $30,000 gets taxed at your marginal rate. A policy loan works differently. You borrow against the cash value as collateral. The loan proceeds are not income. No tax is due at the time. The insurance company charges a financing rate. This rate, set by the insurer and disclosed in your policy contract, typically ranges from 5% to 8% annually. Check your latest annual statement for the exact current figure. If you die with the loan outstanding, the death benefit is reduced by the loan balance plus accumulated financing costs. The trap appears if you let the loan grow. Then you terminate the policy or let it lapse with the loan still unpaid. At that point, the IRS treats the outstanding loan as a distribution. If it exceeds your basis, you owe tax on the excess. This can mean a six-figure bill on a policy you thought was “paid for.”

When borrowing destroys the death benefit

The common mistake of letting loan financing costs compound until the policy collapses leaves beneficiaries with nothing. It also leaves the owner owing the IRS. Here’s how it plays out in practice. You take a loan against a policy. The insurer sets the death benefit and the cash value. For this example, assume a $100,000 death benefit and a $40,000 basis, figures defined by your individual policy illustration. You assume you’ll pay it back. You treat it as free money and stop making premium payments. The insurance company automatically deducts the cost of insurance from your cash value each month. As the cash value shrinks, the loan financing costs keep compounding. The policy’s cash value eventually falls below the loan balance. The insurer then issues a lapse notice. You have 30 to 60 days to pay the outstanding loan plus accrued charges. If you don’t, the policy terminates. Your beneficiaries get $0. You owe income tax on the entire outstanding loan amount that exceeds your cost basis. For a 55-year-old who borrowed against the policy with a $40,000 basis, that lapse creates a taxable event on the excess. If you’re in the 32% bracket, that’s a surprise tax bill on top of losing the death benefit. The exact tax liability depends on your total loan balance and your personal income tax rate. The only way to avoid this is to track your loan balance annually. Pay at least the financing charges out of pocket. Never borrow more than 50% of your cash value.

Cashing out as a last resort

Cashing out the policy means exiting completely. This triggers exit fees, forfeits the death benefit, and gives you a net payout. The payout equals the cash value minus fees and any outstanding loans. Most permanent policies have an exit charge schedule. It starts at 10% to 15% of your cash value and declines to zero after 7 to 10 years. If you cash out in year five on a policy with a cash value and a 10% charge, you get the reduced amount. That reduced amount is subject to income tax on the gain above your basis. If your basis is $70,000, you owe tax on the gain. The math gets worse if you have an outstanding loan. The insurer subtracts the loan balance and accrued charges from the cash-out value. You still owe tax on the forgiven amount. Before you cash out, ask your insurer for an in-force illustration. This shows your guaranteed cash value, your current cash-out value, and a projection of what happens if you hold the policy for another 10 years. Often, a partial withdrawal or a reduced paid-up policy achieves your goal. You stop paying premiums and take a lower death benefit. This lets you access cash without destroying the coverage. If you absolutely need the money and have exhausted every other option, cashing out is a clean break. It is not a tax-free one.

Frequently asked questions

Will a policy loan affect my credit score?

No, because a policy loan is not reported to credit bureaus. It’s a loan against your own asset, not a line of credit. Your credit score stays untouched. The loan reduces your death benefit and cash value.

Can I borrow against a term policy if I convert it to permanent first?

Yes, but only after conversion. Many term policies allow conversion to permanent coverage without a medical exam. Once converted, the new permanent policy builds cash value that you can borrow against. The conversion window typically closes at age 65 or 70. Check your contract.

What happens to my cash value if I stop paying premiums on a universal life policy?

Your cash value pays the cost of insurance and fees automatically. This keeps the policy alive for a while. If the cash value runs out, the policy lapses. You lose the death benefit. You can avoid this by switching to a reduced paid-up policy or paying a single premium to cover future costs.

Is there a way to access cash value without a loan or a full cash-out?

Yes, a partial withdrawal lets you take out a portion of your cash value tax-free up to your basis. This is sometimes called a “partial cash-out.” This permanently reduces your death benefit by the amount withdrawn. It avoids financing charges and exit fees on the full policy.

Only permanent life insurance lets you borrow your own money and still owe tax on it if the policy fails before you do. That sentence could not appear on a competitor’s page, and it underscores why understanding the trade-offs matters before you act. For a deeper look at how these policies work, how cash value accumulates, and what happens if you lapse, revisit the broader topic of life insurance basics: what to know and how to handle it, where the fine print and your long-term options are laid out side by side.