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What is It?

When you pay premiums on a cash value life insurance policy, some of your money is applied toward the policy cash value, which is similar to a savings account within the policy. Over time, cash values accumulate. During your lifetime, you can access the cash value by a withdrawal, policy loan, or surrender (cancellation) of the policy.

How Can You Access the Cash Value in Your Policy?

The cash value in your policy can be accessed in one of three ways: withdrawals, policy loans, or surrender of the policy.


When the time comes to pay your child's college tuition, one option is to withdraw some or all of the cash value of your policy, much like a withdrawal from a bank account. The amount you can withdraw is generally limited to a percentage of the cash value, and varies by policy and company. Most insurance companies charge a processing fee for such withdrawals.

The main advantage of cash value withdrawals is that such withdrawals up to your policy basis, are not considered taxable income (as long as your policy is not a modified endowment contract (MEC) policy, discussed later). Taxation is based on the FIFO accounting method (first in, first out). In other words, the first dollars you take out are considered a return of the premiums that you paid in.

Example(s): Suppose you own a life insurance policy with a cash value of $15,000. Your basis in the policy equals $12,500. You plan to take a withdrawal of $7,000 now to pay for part of your son's tuition. The result is you won't have to pay tax on this withdrawal amount because it will be considered a return of your policy basis.

Caution: Withdrawals are treated as taxable to the extent that they exceed your basis in the policy.

Caution: Cash value withdrawals that occur in the first 15 years of the policy and are accompanied by a reduction in the face amount of the policy may be subject to taxation according to the LIFO (last-in, first-out) method. In this case, the withdrawals are treated as coming first from interest.

Caution: There are special taxation rules for policies that are classified as modified endowment contract (MEC) policies.

The main disadvantage of cash value withdrawals is that such withdrawals will lower your death benefit (i.e., the sum of cash that is paid by the insurance company at your death).

Policy Loans

Cash values can be borrowed against using a policy loan. Policy loans are allowed under the terms of your insurance contract and are not affected by your current financial position. In other words, you won't have to undergo a credit check or bank loan approval process for a policy loan. When you take out a policy loan, the check you receive comes out of the general funds of the insurance company, not your cash value. Your policy cash value serves as collateral for the loan.

The interest rate on a policy loan is known in advance and may be lower than that on a bank loan. Some policies allow you to borrow at an interest rate only slightly higher than the rate being credited to cash values. With other policies, the interest rate on the loan equals the rate credited to cash values, for a zero net cost loan. for a list of different policies and an in-depth discussion of their individual characteristics. Note that interest accrues on any unpaid loan balance. If you choose not to repay the loan, the accruing interest may erode your cash values and result in the lapse of the policy. Unfortunately, the interest you pay on a policy loan for education expenses is not tax deductible.

Caution: If you die with an outstanding policy loan against your account, your death benefit is reduced by the amount of the outstanding loan balance.

The main benefit of policy loans is that the loan proceeds are generally not subject to income tax. This is true even if the loan is larger than the amount of premiums you have paid into the policy, except in the case of a policy treated as a modified endowment contract (MEC).

Example(s): You own a life insurance policy (which is not a MEC) with a cash value of $20,000. Your basis in the policy is $17,000. You decide to take a policy loan to pay your daughter's college tuition. Under the terms of your policy, you are allowed to take a loan for an amount up to 90 percent of the policy cash value, in this case $18,000 ($20,000 x.90). If you take the $18,000 loan, you are not subject to tax on the amount of the loan, even though the loan is larger than your basis.

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Withdrawals and Policy Loans Combined

Cash value withdrawals and policy loans are not mutually exclusive. You can use a combination of withdrawals and loans to maximize the tax-free cash withdrawal benefits. For example, you might choose to make cash value withdrawals up to the amount of your policy basis and then take a policy loan.

Example(s): You have a daughter you are putting through college and you want to access the cash value in your life insurance policy. You might make a tax-free withdrawal of the cash value from the policy in an amount equivalent to the amount of premiums you have paid into the policy. After you withdraw up to your basis in the policy, you might then take out a policy loan. In insurance terms, this is referred to as a "surrender to basis and switch to a loan.


In addition to withdrawals and policy loans, you can surrender (cancel) your policy. The final cash value can then be put toward private school or college tuition. However, surrender fees will likely be charged if you cancel the policy. These charges will vary depending on how early or late in the life of the policy the cancellation occurs. For example, some policies carry a 15- to 20-year surrender schedule. In addition, when you surrender your policy for cash, the gain on the policy is subject to federal income tax (your gain is the difference between the net cash value and your policy basis).

Caution: If you surrender your policy while there is an outstanding policy loan, there could be additional tax consequences.

Can Your Child Access the Cash Value in the Policy?

If you own a cash value life insurance policy, you may choose to gift the policy to your child. In order to attain the maximum tax benefit, you may want to withdraw the cash value up to your basis in the policy before making the gift.

Example(s): Your son is in college and you are considering making a gift to him of your cash value life insurance policy. Before you make the gift, you can make a tax-free withdrawal of the cash value in an amount equal to the amount of premiums you have paid into the policy. You then gift the policy to your son. As the new owner, he can now make withdrawals from the cash value. His withdrawals will be taxed at his income tax rate, which is most likely lower than your rate. Also, your son can take a policy loan against the remaining cash value.

Caution: You may need to continue the gift with additional gifts of the premiums in order to keep the policy in force. Otherwise, the policy may lapse.

Be aware that gifts of life insurance policies and/or premiums may have gift tax implications.



This material was prepared by Broadridge Investor Communication Solutions, Inc., and does not necessarily represent the views of  The Retirement Group or FSC Financial Corp. This information should not be construed as investment advice. Neither the named Representatives nor Broker/Dealer gives tax or legal advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. The publisher is not engaged in rendering legal, accounting or other professional services. If other expert assistance is needed, the reader is advised to engage the services of a competent professional. Please consult your Financial Advisor for further information or call 800-900-5867.


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