Withdrawals in IUL

While policy loans get most of the attention when discussing IUL cash value access, withdrawals offer a different approach to using your accumulated funds. Unlike loans that you borrow and can repay, withdrawals permanently remove money from your policy—it’s gone for good, along with its future growth potential.

This permanence might sound like a disadvantage, but withdrawals actually offer distinct benefits in the right situations. They don’t carry interest charges like loans do. Withdrawals up to your basis (total premiums paid) are tax-free. There’s no loan balance growing through compound interest or threatening policy lapse. And in later life stages when maximizing death benefit becomes less important than accessing cash, withdrawals can be simpler and more straightforward than managing loans.

Understanding how withdrawals work, when they make sense, and how they differ from policy loans helps you make informed decisions about accessing your IUL cash value. The choice between loans and withdrawals isn’t always obvious—each method has advantages depending on your circumstances, goals, and timing.

Whether you’re planning retirement income strategies, facing unexpected expenses, or simply trying to understand all your options for accessing cash value, this guide explains everything you need to know about IUL withdrawals.

Summary

Withdrawals in IUL permanently remove cash value from the policy, reducing both available cash and death benefit. Unlike policy loans, withdrawn amounts cannot be returned to the policy. Withdrawals up to basis (total premiums paid) are typically tax-free, treated as return of your own contributions, while amounts exceeding basis are taxed as ordinary income. Benefits include no interest charges, simplified management without loan balances to monitor, immediate permanent access to funds, and tax-free access up to basis. Drawbacks include permanent reduction in cash value and death benefit, loss of future growth potential on withdrawn amounts, potential taxation if exceeding basis, and reduced policy sustainability if excessive. Withdrawals work best for amounts within basis, later life stages when death benefit is less critical, situations where loan interest is undesirable, and when permanent rather than temporary access is needed. Effective withdrawal strategy requires understanding your basis, planning to minimize taxation, maintaining adequate remaining cash value, and coordinating with overall financial and estate plans.

How Withdrawals Work in IUL

Understanding the mechanics of withdrawals helps clarify how they differ from loans and when they’re appropriate.

Permanent removal of cash value: When you withdraw money from your IUL, that amount is permanently removed from your policy. Unlike a loan that uses cash value as collateral while leaving it in the policy, a withdrawal actually takes the money out. It’s gone, along with any future growth that money would have generated.

Immediate reduction in death benefit: Most IUL policies reduce the death benefit dollar-for-dollar when you make withdrawals. If you have a $500,000 death benefit and withdraw $50,000, your death benefit becomes $450,000. Some policies might reduce the death benefit by a greater amount depending on policy design and the cost of insurance calculations.

No interest charges: Since you’re taking your own money rather than borrowing, there are no interest charges on withdrawals. This is a significant advantage over loans, which accrue interest whether you make payments or not.

Processing and access: You request withdrawals through your insurance company, typically by phone, online portal, or through your agent. Processing takes several days to two weeks, with funds delivered via check or direct deposit. The timeline is similar to policy loans.

Withdrawal limits: You can generally withdraw up to your available cash value, though some policies have minimum withdrawal amounts (often $500-$1,000) and may limit frequency of withdrawals. You typically can’t withdraw amounts that would cause your policy to lapse due to insufficient cash value to cover ongoing charges.

No repayment option: Unlike loans, you cannot “repay” a withdrawal. Once withdrawn, the money is permanently out of your policy. If you later want to rebuild cash value, you’d need to make additional premium payments, which would take time to accumulate.

Tax implications at withdrawal: The tax treatment depends on how much you withdraw relative to your basis. Withdrawals up to your total premiums paid are tax-free. Amounts exceeding your basis are taxable as ordinary income in the year withdrawn.

Tax Treatment of Withdrawals

Understanding the tax implications of IUL withdrawals is crucial for minimizing tax burden and planning strategically.

The basis concept: Your basis in a life insurance policy is the total amount of premiums you’ve paid over the years. If you’ve paid $100,000 in premiums over 20 years, your basis is $100,000. This represents your after-tax contributions to the policy.

Tax-free up to basis: Withdrawals up to your basis are treated as return of your own contributions and aren’t taxable. This is similar to withdrawing contributions from a Roth IRA—you’re getting back money you already paid taxes on. This makes withdrawals up to basis very attractive from a tax perspective.

Taxable above basis: Once you’ve withdrawn an amount equal to your basis, additional withdrawals are taxed as ordinary income. If your basis is $100,000 and you’ve accumulated $200,000 in cash value, the first $100,000 withdrawn is tax-free, but the next $100,000 would be fully taxable.

FIFO ordering: The IRS uses first-in-first-out (FIFO) treatment for life insurance withdrawals. This means withdrawals are treated as coming from your basis first, making initial withdrawals tax-free. This is favorable compared to annuities, which use LIFO (last-in-first-out) treatment where earnings come out first and are immediately taxable.

Impact of previous loans: Outstanding policy loans reduce your basis for withdrawal purposes in some situations. The calculation can become complex when combining loans and withdrawals, making professional guidance valuable for tax planning.

Modified Endowment Contract (MEC) exception: If your policy is a MEC (due to overfunding beyond IRS limits), withdrawal tax treatment changes to LIFO—earnings come out first and are taxable, plus a 10% penalty if you’re under 59½. This makes withdrawals from MECs much less attractive.

No early withdrawal penalty for non-MEC policies: Unlike retirement accounts, non-MEC life insurance withdrawals don’t carry early withdrawal penalties regardless of your age. This provides access flexibility without the 10% penalty that applies to IRA or 401(k) withdrawals before 59½.

Reporting requirements: Insurance companies report withdrawals to the IRS. You’ll receive a 1099-R form showing the amount withdrawn and any taxable portion, which you report on your tax return.

When Withdrawals Make More Sense Than Loans

While loans often get more attention, withdrawals are actually preferable in specific situations.

When amounts are within your basis: If you need money and haven’t yet withdrawn an amount equal to your total premiums paid, withdrawals are tax-free with no interest charges. This makes them superior to loans for these amounts. Why borrow money and pay interest when you can withdraw your own contributions tax-free?

In later life stages: As you age and your emphasis shifts from leaving maximum death benefits to maximizing your own use of assets, withdrawals become more attractive. If you’re 80 years old and death benefit preservation is less critical than accessing funds, permanent withdrawal makes sense.

For known, permanent needs: When you know you’ll never “repay” the money, withdrawals are cleaner than loans. Loans that are never repaid still accrue interest and create ongoing balances to monitor. Withdrawals are final—no ongoing management needed.

When avoiding interest charges matters: If you’re particularly concerned about not paying interest on your own money, withdrawals (up to basis) provide access without any cost beyond the opportunity cost of lost growth.

For simplifying management: In complex financial situations where you’re already managing multiple accounts and obligations, eliminating the need to track loan balances and interest can be valuable. Withdrawals are simpler—take the money and move on.

When policy performance is poor: If your policy is underperforming and you’re considering surrendering it anyway, withdrawals while keeping the policy alive might be preferable to a full surrender, especially if remaining death benefit has value or if you want to keep options open.

In combination with loan strategies: Many people withdraw up to their basis tax-free, then use loans for additional amounts needed. This “withdraw first, then borrow” approach maximizes tax-free access.

Risks and Drawbacks of Withdrawals

Withdrawals carry their own risks that require understanding and consideration.

Permanent loss of cash value: The most fundamental drawback is that withdrawn money is gone forever, along with all future growth it would have generated. If you withdraw $50,000 that would have grown to $100,000 over the next 20 years, you’ve given up that growth opportunity.

Immediate death benefit reduction: Your beneficiaries receive less when you die. If maximizing inheritance is important, withdrawals work against this goal. Each dollar withdrawn is a dollar less for heirs.

Reduced policy sustainability: Large withdrawals deplete the cash value that pays ongoing insurance costs. If you withdraw too much too quickly, remaining cash value might not sustain the policy, forcing you to make premium payments or face lapse.

Loss of compounding: Cash value compounds over time—earnings on earnings. When you withdraw money, you lose not just current value but all future compounding on that amount. The longer your time horizon, the more significant this opportunity cost becomes.

Tax implications beyond basis: Once you exhaust your basis, withdrawals become fully taxable. If you’ve paid $150,000 in premiums and withdraw $200,000 over several years, that last $50,000 is taxable income, potentially pushing you into higher tax brackets.

Inflexibility: Unlike loans that can be repaid if circumstances change, withdrawals can’t be undone. If you withdraw funds for an opportunity that falls through, you can’t simply return the money to the policy.

Policy lapse risk: Excessive withdrawals can cause policy lapse if remaining cash value becomes insufficient to cover insurance costs. Lapsed policies lose all benefits and can create tax consequences.

Impact on policy riders: Withdrawals might affect certain policy riders or benefits tied to cash value levels. Check your specific policy provisions to understand how withdrawals impact other features.

Strategic Withdrawal Planning

Thoughtful planning maximizes withdrawal benefits while minimizing drawbacks and risks.

Know your basis: Before making any withdrawals, understand exactly how much you’ve paid in premiums over the life of the policy. This tells you how much you can withdraw tax-free. Request a basis calculation from your insurance company if you’re unsure.

Withdraw up to basis first: If you need to access cash value, withdraw up to your basis before taking loans. This strategy maximizes tax-free access—you get money without interest charges or taxes. Only after exhausting basis should you consider loans for additional amounts.

Maintain adequate cash value: Don’t withdraw so much that remaining cash value can’t sustain the policy. Request in-force illustrations showing how proposed withdrawals affect long-term policy sustainability. Maintain a buffer to ensure the policy remains viable.

Consider timing: The timing of withdrawals can matter for tax planning. If you’re in a temporarily high tax bracket, delaying withdrawals beyond basis until a lower-income year minimizes taxes. Conversely, if you’re in an unusually low bracket, taking taxable withdrawals might make sense.

Coordinate with other income: Plan withdrawals considering your other income sources. If large withdrawals beyond basis push you into higher tax brackets or affect Social Security taxation, it might be better to spread withdrawals across multiple years.

Document everything: Keep records of all premiums paid and all withdrawals. This documentation supports your basis calculation and helps with tax reporting and planning.

Review policy impact regularly: After making withdrawals, obtain updated policy illustrations showing revised death benefit, remaining cash value, and projected future performance. Understand how withdrawals have changed your policy’s trajectory.

Plan for end-game scenarios: In later years, consider your ultimate goals. If you want to maximize use of cash value and care less about death benefit, systematic withdrawals might make sense. If preserving death benefit is important, be more conservative with withdrawals.

Withdrawals vs. Loans: Making the Choice

Understanding when to use withdrawals versus loans helps you optimize your access strategy.

Use withdrawals when:

– The amount needed is less than your basis (making it tax-free)

– You’re certain you won’t repay the money

– You want to avoid interest charges

– You prefer simple, final transactions over ongoing loan management

– You’re in later life and death benefit preservation is less critical

– You want to reduce death benefit intentionally for estate planning reasons

Use loans when:

– You need amounts exceeding your basis and want to avoid taxation

– You might repay the money, either partially or fully

– You want to maintain maximum cash value continuing to earn returns

– Preserving death benefit is important (since loans can be repaid)

– You’re using a retirement income strategy designed around tax-free loan access

– Your policy has favorable loan provisions with non-direct recognition

Combination strategies:

– Many people use both—withdraw up to basis tax-free, then take loans for additional amounts

– This maximizes tax-free access (through withdrawals to basis) while maintaining some cash value growth potential (through loans on amounts beyond basis)

– The hybrid approach provides tax efficiency and flexibility

Consult professionals: Tax advisors, financial planners, and insurance agents familiar with IUL can help model different scenarios showing the impact of withdrawals versus loans on taxes, policy performance, and death benefits. This professional guidance often pays for itself through better decisions.

Common Withdrawal Mistakes to Avoid

Many policyholders make predictable mistakes when taking IUL withdrawals. Awareness helps you avoid them.

Withdrawing without knowing your basis: Taking withdrawals without understanding your basis means you might unnecessarily trigger taxes or miss opportunities for tax-free access. Always know your basis before withdrawing.

Excessive early withdrawals: Taking large withdrawals in the early years when cash value hasn’t had time to grow significantly can cripple the policy. Give your policy time to build substantial cash value before taking major withdrawals.

Ignoring surrender charges: Some policies have surrender charges in early years that reduce the amount you receive from withdrawals. Understand any surrender charge schedules before withdrawing significant amounts.

Failing to consider death benefit impact: People focused on accessing cash sometimes forget that every dollar withdrawn is a dollar less for beneficiaries. Consider your heirs’ needs when making withdrawal decisions.

Not requesting updated illustrations: After withdrawals, get new policy projections. Many people withdraw money and never check how it affected their policy’s long-term viability, discovering problems only when it’s too late.

Withdrawing in high-income years: If you’re withdrawing amounts beyond basis, doing so in a year when you’re already in a high tax bracket maximizes the tax hit. Strategic timing can reduce taxes significantly.

Treating withdrawals casually: Because withdrawals are easy to request, some people treat them like ATM machines, making frequent small withdrawals for non-essential purposes. This death-by-a-thousand-cuts approach gradually undermines the policy.

Not coordinating with overall financial plan: Withdrawals should fit into your broader financial strategy, not be made in isolation. Consider how they interact with retirement accounts, Social Security, pensions, and other income sources.

You can book a free strategy session with us. We will be glad to help,you set up a policy and to help you make the most of it to achieve your aims and objectives.

Conclusion

Withdrawals offer a straightforward way to access IUL cash value, particularly attractive for amounts within your basis where they’re tax-free and have no interest charges. They provide permanent access without the complexity of managing loan balances and work especially well in later life stages when death benefit preservation becomes less critical than maximizing your own use of accumulated assets.

However, the permanence of withdrawals means they should be approached thoughtfully. Withdrawn amounts are gone forever, along with their future growth potential. Excessive withdrawals can threaten policy sustainability and significantly reduce death benefits for heirs.

The key is strategic use—understanding your basis, withdrawing tax-free up to that amount when needed, maintaining adequate remaining cash value, and coordinating withdrawals with your broader financial plan. For many people, a hybrid strategy of withdrawing up to basis then using loans for additional needs provides optimal tax efficiency and flexibility.

Whether withdrawals or loans are better for your situation depends on your specific circumstances, goals, and timing. The good news is that IUL policies offer both options, giving you flexibility to choose the access method that best fits each situation. Work with knowledgeable professionals to model different approaches and make informed decisions that align with your financial objectives.

Withdrawals are a valuable tool in the IUL toolbox. Like any tool, they work best when used appropriately for the right purposes at the right times. Understanding how they work, when they make sense, and how to use them strategically helps you maximize the value of your IUL policy throughout your lifetime.

Indexed Universal Life Insurance(IUL) policies have a lot of features that can potentially provide a safety net for you and for your loved ones. You should check out this video on how to safeguard your future and that of your loved ones against unforseen circumstances like job loss or illnesses.

FAQs

Question 1: Can I return money to my policy after making a withdrawal?

Answer: No. Withdrawals permanently remove money from your policy—you cannot deposit it back. This is the fundamental difference between withdrawals and loans. If you think you might want to return money to the policy later, a loan is more appropriate. You could make new premium payments to rebuild cash value, but that’s different from reversing a withdrawal.

Question 2: How do I find out my basis in my IUL policy?

Answer: Contact your insurance company or agent and request your policy basis calculation. They can provide a statement showing total premiums paid (your basis) and total withdrawals taken to date. This information is crucial for tax planning before making withdrawals.

Question 3: Will my insurance company automatically stop me from withdrawing too much?

Answer: Insurance companies typically won’t allow withdrawals that would cause immediate policy lapse, but they generally won’t prevent withdrawals that create future sustainability problems. It’s your responsibility to ensure withdrawals don’t compromise long-term policy health. Request in-force illustrations before making large withdrawals to understand the impact.

Question 4: Are there penalties for taking withdrawals from my IUL?

Answer: For non-MEC policies, there are no early withdrawal penalties regardless of your age. However, some policies have surrender charges in the early years (typically first 10-15 years) that reduce the amount you receive. Also, withdrawals beyond your basis are subject to ordinary income tax. MEC policies face a 10% penalty on taxable withdrawals if you’re under 59½.

Question 5: Can I take withdrawals and loans at the same time?

Answer: Yes, you can use both access methods, and many people do. A common strategy is withdrawing up to basis (tax-free) while simultaneously maintaining loans for amounts beyond basis. However, the combined impact of both withdrawals and loans on your cash value and policy sustainability requires careful monitoring to ensure the policy remains viable.