Can You Withdraw From Life Insurance? What High-Income Parents Should Know

By Kevin Luu, Co-Founder and Chief Learning Officer. Reviewed on 2026-09-30.

You can withdraw money from life insurance only if the policy has cash value, which means permanent coverage such as whole life, universal life or variable universal life. Term life, including the group term life most employers provide, has no cash value, so there is nothing to withdraw or cash out while you are alive and healthy. With a permanent policy you have four ways to get money: a partial withdrawal, a policy loan, a full surrender, or selling the policy, and each one is taxed and affects the death benefit differently.

For a two-income household earning $750,000 or more in California or Washington, the question usually comes up in one of three moments: a job change that ends employer coverage, an old whole life policy bought years ago that no longer fits, or a need for cash for a home purchase. The right answer depends on what the coverage is still doing for your children, not only on the tax bill.

Which policies can you actually take money from

One exception applies to every type, including term: many policies include an accelerated death benefit rider. If the insured is terminally or chronically ill, part of the death benefit can be paid early, and IRS Publication 525 says certain accelerated death benefits are excluded from income in that case (IRS Pub 525). That is a medical provision, not a way to access savings.

Why group life through work cannot be cashed out

This is the most common version of the question among W-2 families. Employer group-term life is pure term coverage. IRS Publication 15-B describes a permanent benefit as an economic value extending beyond one policy year, “for example, a paid-up or cash-surrender value” (IRS Pub 15-B (2026)), and plain group-term coverage does not build one. No cash value means nothing to cash out. Some employers also offer group universal life as a separate voluntary benefit, which can build cash value, so check which product your benefits portal actually shows.

Group coverage also has a small tax cost many people never notice. For 2026, the cost of coverage above $50,000 is added to your wages in boxes 1, 3 and 5 of your W-2 (code C in box 12), using the IRS Table 2-2 rate for your age. At ages 40 to 44 that rate is $0.10 per $1,000 of coverage per month.

Example. A 42-year-old Genentech scientist has $400,000 of employer group term coverage and pays nothing toward it. Imputed income for 2026 is ($400,000 minus $50,000) / $1,000 x $0.10 x 12 = $420. For a household in the 37% federal bracket, that adds roughly $150 to $160 of federal income tax a year, plus Medicare tax and California tax. Small, but it shows up on every pay stub, and it is a reminder that the coverage ends when the job does.

When you leave, check the group certificate for a conversion or portability option and its deadline, which is typically short. For a family with young children, the bigger risk is not the cash; it is a gap in coverage while you are between employers or after a health change makes new individual coverage expensive.

Four ways to get money from a permanent policy, and how each is taxed

1. Partial withdrawal

For a policy that is not a modified endowment contract (MEC), withdrawals are generally treated as a return of your basis first. Basis is roughly the premiums you paid minus amounts you already received tax-free (Pub 525). You typically owe no income tax until withdrawals exceed that amount (IRC §72(e)). One trap: in the first 15 years, a withdrawal that comes with a reduction in the death benefit can be taxed as gain first under IRC §7702(f)(7). A withdrawal permanently reduces the death benefit.

2. Policy loan

A loan from the insurer, secured by the cash value, is generally not taxable while the policy stays in force. Interest accrues, and any unpaid loan reduces what your family receives at death. The risk is a lapse: if the loan plus interest grows larger than the cash value, the policy terminates and the loan is treated as money you received, which can create taxable gain in a year you got no cash. On the “immediately” question: a new policy usually has little borrowable value in its early years, so a loan is rarely available right after purchase.

3. Full surrender

Surrendering ends the coverage. Pub 525 is direct: you include in income any proceeds that are more than the cost of the policy. The gain is ordinary income, not a capital gain.

4. Selling the policy (life settlement)

If the insured is older or in poorer health, a third party may pay more than the surrender value. For most families with children under 12, the insured parent is too young and healthy for this to be attractive, and the tax treatment of a sale is more involved than a surrender. Treat it as a question for your CPA before signing anything.

How MEC status changes the tax on withdrawals and loans

A policy that was funded faster than the federal seven-pay test allows becomes a modified endowment contract (IRC §7702A). High earners can trip this test when they put large lump sums into a policy. For a MEC, withdrawals and loans are taxed gain first, and the taxable part generally carries a 10% additional tax if you are under 59½ (IRC §72(e)(10) and §72(v)). Your insurer can tell you in writing whether the policy is a MEC. Ask before you take any money.

Worked example: an old whole life policy for a Bay Area family

Assumptions (illustrative): a married couple filing jointly, $1.1 million of W-2 income, living in California, two children ages 4 and 7. Ten years ago one spouse bought a whole life policy. Premiums paid: $120,000. Current cash surrender value: $150,000, with no remaining surrender charge. The policy is not a MEC and there is no outstanding loan. Assume federal taxable income is above $768,700, so extra ordinary income is taxed at 37% federally for 2026. Assume California taxable income is between $1 million and $1,485,906, so the marginal California rate is 11.3% plus the 1% Behavioral Health Services Tax, 12.3% in total (2025 rates; 2026 schedules are not yet published).

The Washington row is a 2026 answer. Washington does not currently have an individual income tax, but a 9.9% tax on individuals and joint filers with AGI over $1,000,000 takes effect January 1, 2028 (Washington DOR), so a surrender in 2028 or later may also face Washington tax.

If the same policy were a MEC, a $100,000 withdrawal would pull out the $30,000 of gain first. That is about $14,790 of federal and California income tax, plus a $3,000 additional tax if the owner is under 59½.

The tax is only half of the decision. With two young children, the question to answer first is whether the family still needs that death benefit. If it does, and term coverage would cost less for the same protection, the usual sequence is: buy the replacement term policy, wait until it is in force, then decide what to do with the old contract. A §1035 exchange into another policy or an annuity is generally tax-free and carries the basis over instead of triggering the gain, as long as no cash or loan relief comes out in the exchange.

Alternatives to surrendering life insurance

• Reduced paid-up: stop paying premiums and keep a smaller, fully paid death benefit.
• Use dividends to pay premiums on a participating whole life policy, which lowers your out-of-pocket cost without ending coverage.
• Partial withdrawal or loan for a one-time need, with a written plan to repay or to monitor lapse risk.
• §1035 exchange into a lower-cost policy or an annuity.

Common mistakes

• Cancelling an old policy before new coverage has been approved and issued.
• Taking a loan and never checking the annual statement until a lapse notice arrives.
• Assuming a policy is not a MEC because it “looks like” whole life.
• Cashing out a policy you own on your child’s life without asking what it was bought for. The gain is taxed to the owner, usually the parent, and if the policy is held in a UTMA account the custodian can use the money only for the child’s benefit.
• Forgetting that the beneficiary designation, not your will, decides who receives the death benefit. If a trust is meant to receive it for minor children, confirm the designation actually names the trust.

What to write down for your children

Most families who own a permanent policy cannot say, ten years later, why they bought it. Write one short Decision Memo per policy: who owns it, who is insured, who the beneficiary is, what it was meant to pay for, whether it is a MEC, and what you decided about keeping, borrowing or surrendering, and why. Conversations fade. Documentation compounds.

FAQ

Are cash value withdrawals taxable?

For a policy that is not a MEC, withdrawals are generally tax-free until they exceed your basis, which is roughly the premiums you paid minus amounts already received tax-free. Anything above basis is ordinary income. For a MEC, the gain comes out first and is taxable, generally with a 10% additional tax before age 59½. A withdrawal in the first 15 years that also reduces the death benefit can be taxed as gain first.

Can I cash out my term life insurance?

No. Term life has no cash value, so there is nothing to cash out, and letting it lapse returns nothing. Some term policies have a return-of-premium feature or an accelerated death benefit rider for terminal or chronic illness, and many can be converted to permanent coverage before a deadline set in the contract. Read the policy for those options before cancelling.

Can I cash out my child’s life insurance policy?

If you are the owner, usually yes, if it is a permanent policy with cash value. Surrender gain above the premiums paid is taxable to the owner. If the policy was transferred to the child or to a UTMA custodian, the money belongs to the child and must be used for the child’s benefit. Check who is listed as owner on the policy statement first.

Next step

Pull the most recent annual statement for each policy and ask the insurer for three numbers in writing: cash surrender value, cost basis, and MEC status. With those, the decision is much easier to work through. If you want help working through it alongside your equity compensation and estate plan, our estate planning and employee benefits teams cover it in the Tax & Wealth Assessment. Related reading: withdrawing from a universal life policy, how to get out of a whole life policy, withdrawing dividends from life insurance and naming a trust as beneficiary.

This is general education, not individual tax or insurance advice. The right move depends on your family’s full picture.

Written by

Kevin Luu

Co-Founder and Chief Learning Officer, Bright Advisers

Kevin has advised high-income W-2 tech and biotech families since 2015, and leads the education-first Age Five Family Office from Brea, California.

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