You can cash out life insurance before death only if you own a permanent policy, such as whole, universal, or variable life, because those policies build cash value you can access through a withdrawal, a loan, a full surrender, an accelerated death benefit, or a sale to a third party. Term life has no cash value and nothing to pay out while you’re alive. Which route makes sense depends on how much you need, whether anyone still depends on the death benefit, your health, and the tax classification of the policy.
Some term policies include a conversion option that lets you switch to permanent coverage without a new medical exam, but conversion must happen before a deadline in the contract, and the new policy starts building cash value from scratch at higher premiums.
Three Ways to Pull Money From a Permanent Policy
Once your policy has accumulated enough equity, you have three basic options. Each one does something different to your death benefit and your tax bill.
Partial Withdrawal
A withdrawal takes money directly out of your cash value. Your death benefit typically drops by the amount you take. For a standard permanent policy that is not a modified endowment contract, withdrawals come out of your basis first, so they’re tax-free up to the total premiums you’ve paid. Only amounts above basis are taxed as ordinary income.
Policy Loan
A policy loan uses your cash value as collateral rather than removing it. The insurer lends you money against the policy and charges interest, which compounds. As long as the policy stays in force, the loan is not treated as a taxable distribution on a standard policy. The danger is quiet: no one sends you a bill, and if the growing loan balance reaches your remaining cash value, the insurer forces a lapse. You lose the death benefit, and you may receive a Form 1099-R reporting a taxable gain even though no cash ever reached you. The IRS calls this phantom income, and it hits hardest when a long-running loan sits on top of a modest basis.
Full Surrender
A surrender ends the contract. The insurer pays you the net cash value minus any outstanding loan balance, accrued interest, and surrender charges. Most insurers apply surrender charges during the first several years of the policy, typically starting around 7% to 10% of the cash value and declining each year until they reach zero, often after seven to ten years. Anything you receive above your total premiums paid is taxable as ordinary income.
How to Request the Money
Contact your insurer’s administrative office or log into the online portal and ask for a disbursement or surrender form. Have your policy number and most recent annual statement ready. Before you submit anything, request an in-force illustration. That projection shows your current cash value, your surrender value after charges, and how a withdrawal or loan would reshape the death benefit going forward. It relies on assumptions about future interest and costs, so it won’t be exact, but it’s the clearest picture you can get.
The form will ask for your Social Security number and the amount you want, and it will usually include a box to elect federal tax withholding. If your policy names an irrevocable beneficiary, that person generally has to sign off on the release of funds. After you submit the paperwork, expect roughly three to ten business days of processing before the insurer sends an electronic transfer or a mailed check.
If You’re Seriously Ill
A different path opens up when the policyholder is sick, and it often beats a surrender on both the amount received and the tax treatment.
Many life insurance policies include an accelerated death benefit rider. It lets you collect a portion of your death benefit while you’re still alive if a licensed provider certifies either a terminal illness or a chronic illness. For federal tax purposes, “terminally ill” means an illness reasonably expected to result in death within 24 months of certification, though individual insurers sometimes use shorter windows, such as 12 months.1Office of the Law Revision Counsel. 26 USC 101 – Certain Death Benefits “Chronically ill” generally means being permanently unable to perform at least two activities of daily living, such as bathing, dressing, or eating, without substantial assistance, or having severe cognitive impairment.2Interstate Insurance Product Regulation Commission. Group Term Life Uniform Standards for Accelerated Death Benefits
The insurer pays out a percentage of your face value and reduces the eventual death benefit by that amount. Some policies cap the accelerated payout at 75% of the death benefit or a fixed dollar maximum. Amounts received by a terminally ill individual are excluded from gross income. For a chronically ill individual, the exclusion applies only to the extent the payments cover qualified long-term care expenses not reimbursed by other insurance; money spent on anything else can be taxable.1Office of the Law Revision Counsel. 26 USC 101 – Certain Death Benefits
A viatical settlement is the same idea routed through a third-party buyer rather than the insurer. The buyer takes over premiums and collects the death benefit when you die. Because the proceeds are treated as accelerated death benefits under federal tax law, viatical settlements paid to terminally ill individuals are generally exempt from federal income tax, and payouts for chronically ill individuals are excluded on the same long-term-care-cost basis as the rider.
Selling the Policy to a Third Party
If you’re not ill enough to qualify for a viatical settlement but want more than the surrender value, a life settlement is the standard alternative. You sell the policy to a licensed investor or settlement company. The buyer pays you a lump sum that is typically more than the cash surrender value but less than the full death benefit, then takes over premium payments and collects the death benefit later. Most states regulate these sales and give you a rescission period, commonly 15 to 30 days, during which you can cancel.
Taxation on a life settlement is layered. The portion of the proceeds up to your basis (total premiums paid, adjusted for prior withdrawals and cost of insurance charges) is tax-free. The next layer, covering the inside build-up that would have been ordinary income on a surrender, is taxed as ordinary income. Any amount above the cash surrender value is treated as long-term capital gain.3Internal Revenue Service. Revenue Ruling 2009-13
The Modified Endowment Contract Trap
Before you take any money out, confirm whether your policy is a modified endowment contract. The classification changes the tax rules against you and cannot be reversed.
A policy becomes a MEC if you pay more in premiums during the first seven years than the “7-pay test” allows. The test calculates the maximum level premium that would fully pay up the policy in exactly seven annual payments.4Office of the Law Revision Counsel. 26 USC 7702A – Modified Endowment Contract Defined Overfunding, even accidentally, can trigger it.
Once a policy is a MEC, the favorable basis-first rule flips. Every withdrawal or loan is treated as gains coming out first, taxed as ordinary income until all accumulated earnings have been distributed. On top of that, if you’re under 59½ when you take money out, you owe an additional 10% penalty on the taxable portion.5Office of the Law Revision Counsel. 26 USC 72 – Annuities, Certain Proceeds of Endowment and Life Insurance Contracts On a non-MEC, that same loan would not be a taxable event while the policy stays in force.
Swapping the Policy Instead of Cashing It Out
If you no longer need life insurance but don’t want to trigger a tax bill, a 1035 exchange lets you swap the policy for an annuity contract or a qualified long-term care insurance contract without recognizing any gain or loss.6Office of the Law Revision Counsel. 26 USC 1035 – Certain Exchanges of Insurance Policies Your cost basis carries over. The exchange has to run directly between the insurance companies; if the cash passes through your hands first, the tax-free treatment is lost.
What Cashing Out Can Cost You
The financial math is less forgiving than most people expect, and this is where the real mistakes happen.
Surrender charges can take a serious bite early on. If the policy is less than seven to ten years old, the deduction can be meaningful: on $50,000 of cash value at a 7% charge, $3,500 is gone before you see anything.
Loan interest compounds quietly inside the contract. A loan that feels free in year one can collapse the policy a decade later, taking the death benefit with it and leaving a tax bill on gains you never pocketed.
Every dollar you withdraw or borrow against reduces what your beneficiaries receive, and a full surrender eliminates the death benefit entirely. If anyone depends on that payout, a spouse, a business partner under a buy-sell agreement, or a co-signer on a loan, the fallout extends well past your own balance sheet.
Cashing out can also affect means-tested government benefits. Supplemental Security Income counts the cash surrender value of life insurance as a resource, though policies with a combined face value of $1,500 or less are excluded.7Social Security Administration. Understanding Supplemental Security Income SSI Resources Surrendering a policy and depositing the proceeds in a bank account converts them into a countable asset for the next Medicaid or SSI eligibility review, and the timing relative to an application can delay or destroy coverage during a period when you need it most.