When is it wise to take cash from your life insurance policy?

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One of the benefits of having permanent life insurance, such as whole life, is that these policies can build up a cash value.

While most financial planners warn against depleting the cash value of your life insurance policy, there are some circumstances under which it’s a smart move to tap into the assets.

Below, we’ll look at the times when it’s a good idea to draw from your cash value.

Key Takeaways

If you have sufficient cash value in your life insurance policy, you can borrow against it or take cash out.
You can use cash from life insurance to help pay medical bills and some types of debt. .

When should you withdraw from your life insurance?

There are a few times when it makes sense to take money out of your life insurance and a few good ways to use that money. Here are several times when it makes sense to withdraw from your life insurance cash account.

You want to supplement your retirement income

Permanent life insurance policies–including whole life, variable and universal life–often are touted as great tools to add to your retirement savings. One reason is that after a few years of paying premiums they build a cash value. You can borrow against this cash value tax-free. Any distributions not taken as loans will be taxed. However, if you overfund a variable universal life policy and have paid into it for 15 years, IRS guidelines allow you to take tax-free cash withdrawals.

All of this makes permanent life insurance very attractive “if you’re 60 or 70 and you want to create an income stream,” says Adam Sherman, a financial advisor and founding partner at 1847 Private Client Group in PA.

Still, tapping into life insurance money carries a few risks and drawbacks. For starters, any loans obtained and not repaid and any cash withdrawals could decrease the death benefit that your beneficiaries receive. If you withdraw the cash value that was being used to pay your premiums, your policy could lapse.

These create taxable events under IRS rules.

“If the policy lapses or there’s not enough cash to support it, the IRS could come back and tax you at ordinary income rates on all distributions above your cost basis,” Sherman says. “So you need to manage your distributions from your life insurance policy properly to avoid resulting in some serious taxation down the road.”

Your best strategy is to work with qualified professionals, such as insurance agents or brokers. They can run the numbers for you and tell you the maximum amount of income you could withdraw from your policy without risking unwanted taxation.

You have a terminal illness

You could use the cash from your life insurance policy to pay for life-saving surgery or other medical expenses. For example, if you are suffering from a terminal illness, but stand a good chance to live if you can pay for an organ transplant, it’s well worth it to use funds from your life insurance policy. “Organ transplants are considered experimental, so many [health] insurance companies won’t pay for them,” says Jean Dorrell, president of Senior Financial Security in Summerfield, Fla.

Unfortunately, footing those medical bills yourself can set you back a pretty penny. “It usually requires $50,000 or so upfront just to get on a transplant list,” Dorrell says.

There are other serious medical conditions such as cancer which can set you back financially, so the cash in your life insurance policy can help keep you from going into debt over medical bills.

As an alternative to taking out cash, many life insurance companies offer “accelerated death benefits,” also known as “living benefits” or terminal illness riders.

In effect, such riders permit you to take your own death benefit while you’re still alive. Life insurance companies won’t give you the whole benefit. “But maybe they’ll give you 80% or 90% of the death benefit. And it’s tax-free too,” says Dorrell.

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You need insurance money to pay your debts

Most of us don’t want to fool around with the IRS. If you owe federal income taxes, you may have considered using money from your life insurance policy to pay them. Dorrell and Sherman have mixed views on the idea of using a policy’s cash value to reduce debt.

“If your life insurance policy is the only place you have, and you have no other source to draw from and you’re guilt ridden over this [tax] debt and feel like you have to pay it, then yes, go ahead and use life insurance,” Dorrell says. “But that should be the very last place you go to in order to draw from.”

Never take cash from your life insurance policy in order to pay other types of debts, Dorrell cautions.

“You don’t ever want to touch it when you’ve been sued or have judgments against you from, say, a credit card company or a mortgage lender,” Dorrell says. “In most cases, your life insurance is 100% protected from creditors. So if you pull cash value out of there, you’re going to subject that money to possible seizure by a creditor.”

You generally buy life insurance to protect your heirs. Sherman offers his own view of whether it makes sense to pull out cash for your own needs when times get tough.

“If you’re in a pinch and need some money to pay off higher rate credit card debt, or another higher rate loan, I think that it’s reasonable to use [the cash value of] life insurance,” Sherman says. He notes that credit card debt typically carries double-digit interest rates, while the loan interest rate for a universal or variable universal policy is usually is [up to] to 2%, and typically 5 to 8% on a whole life insurance policy.

Sherman also says those forced to liquidate money from a brokerage account–who’d have to pay 15% capital gains taxes–would be better off borrowing money from their life insurance policies.

The cash in your life insurance is yours for any use you see fit, but always be aware of how it affects the policy. This will ensure your policy remains intact for your loved ones when you die.

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Lynnette Khalfani-Cox

Lynnette Khalfani-Cox, The Money Coach®, is a nationally-known personal finance expert, speaker, and New York Times bestselling author. She has also been published by outlets such as AARP, Black Enterprise, Essence, Kiplinger Advisor, The Wall Street Journal, USA Today, and VOX.