Policy Loan vs. Withdrawal: Understanding the Tax Implications of Each

Accessing the cash value of a Permanent Life Insurance policy involves two primary methods—a loan or a withdrawal—with critically different tax consequences. The rule of thumb is to **loan** against gains and **withdraw** only your basis.

Policy Loan (Tax-Free Access)

Policy loans are generally **tax-free** because they are treated by the IRS as debt against collateral (your cash value), not as income. The key benefit is that the money you access via the loan does not increase your taxable income.

Withdrawal (Basis First)

A withdrawal allows you to take cash directly out of the policy. Under the FIFO (First-In, First-Out) rule, withdrawals are tax-free up to the amount of your total premiums paid (your Cost Basis). Once withdrawals exceed the Cost Basis, the gain is taxed as ordinary income.

• MEC Exception: If the policy is a Modified Endowment Contract (MEC), the rules flip to LIFO (Last-In, First-Out), and all gains are taxed first, plus a potential 10% penalty if withdrawn before age 59½.

Disclaimer: This content is for informational purposes only and is not financial or legal advice. Always consult a tax professional before accessing cash from a life insurance policy to avoid unexpected taxation.