What you can and cannot do with life insurance cash value

Some life insurance policies build up cash value over time — whole life, universal life, and variable universal life policies do this. Term life insurance does not. If your policy has cash value, you can borrow against it or withdraw from it, but you cannot directly invest the money yourself through the policy. Instead, the insurance company invests the cash value according to the policy type, and you receive whatever returns that generates.

The distinction matters: you are not choosing stocks or bonds. You are choosing a policy type, and the insurer's investment strategy determines what happens to your money. With whole life, the insurer invests conservatively and guarantees a minimum return. With variable universal life, you pick from a menu of sub-accounts (similar to mutual funds) that the insurer offers, and your returns depend on how those perform.

If you want to use life insurance money for investing, your real options are borrowing against the cash value to invest elsewhere, or withdrawing cash value and investing it outside the policy. Both have tax and coverage consequences you need to understand before you move forward.

Key Takeaways

  • Only whole life, universal life, and variable universal life policies build cash value; term life does not.
  • You cannot invest the cash value yourself — the insurance company invests it, and you receive the returns they generate.
  • You can borrow against cash value at a rate set by your policy, usually lower than bank loans, but the loan reduces your death benefit if you do not repay it.
  • Withdrawing cash value above what you paid in premiums triggers income tax, and withdrawals reduce the amount your beneficiaries receive.
  • Variable universal life policies let you choose from the insurer's investment options, giving you more control than whole life but also more risk.

How policy loans work and what they cost

A policy loan lets you borrow money against your cash value without surrendering the policy. The insurance company lends you the money, and you pay interest on it — the rate is written into your policy contract, often between 5 and 8 percent depending on when the policy was issued and what type it is.

The loan does not require a credit check or income verification. You can use the money for anything: investing, paying bills, or a business venture. The insurer does not care what you do with it. However, if you do not repay the loan, the unpaid balance and interest are subtracted from your death benefit. If the loan grows large enough, it can consume the entire cash value and cause the policy to lapse, leaving your beneficiaries with nothing.

Interest accrues whether you pay it or not. If you take a $50,000 loan at 6 percent and make no payments, the balance grows to $53,000 after one year, then $56,180 after two years. The compounding works against you. Some policies allow you to pay interest only, which keeps the principal from growing but does not reduce what your beneficiaries receive — you are just servicing the debt.

Tax consequences of withdrawals versus loans

Loans have a tax advantage: they are not taxable income. You borrowed money, so the IRS does not treat it as earnings. Withdrawals are different. When you withdraw cash value, the amount above your total premiums paid is taxable as ordinary income in the year you withdraw it.

Example: You paid $100,000 in premiums into a whole life policy over 20 years. The cash value is now $180,000. If you withdraw $50,000, you owe income tax on $30,000 (the amount above your $100,000 basis). The tax rate depends on your overall income that year — it could be 22 percent, 24 percent, or higher. You will receive a Form 1099-R from the insurance company, and you report it on your tax return.

Loans avoid this entirely, which is why some people use them instead of withdrawals. But loans must be repaid, and if you do not repay them, the unpaid balance becomes taxable when the policy ends. If your policy lapses with an outstanding loan, the IRS treats the forgiven debt as income in that year.

How variable universal life gives you investment choices

Variable universal life (VUL) policies let you direct your cash value into sub-accounts that function like mutual funds. The insurer offers a menu — typically 5 to 15 options — ranging from conservative bond funds to aggressive stock funds. You choose how to split your cash value among them, and your returns depend on how those investments perform.

This gives you more control than whole life, where the insurer makes all investment decisions. But it also means your cash value can go down if the market declines. With whole life, your cash value is may provide to grow at a minimum rate set by the policy. With VUL, there is no such may provide. A severe market downturn could reduce your cash value significantly, and if it drops too far, your policy could lapse because there is not enough money to cover the insurance costs.

VUL policies also charge higher fees than whole life — typically 1 to 3 percent annually for the sub-account management, plus the insurance company's charges. Over decades, these fees compound. A whole life policy might charge 1 to 1.5 percent total; a VUL might charge 2 to 3.5 percent. That difference matters when you are trying to build cash value.

Withdrawing cash value and investing it elsewhere

You can withdraw cash value and invest the money outside the policy — in a brokerage account, real estate, a business, or anything else. This severs the money from the insurance policy entirely. You own the investment outright, and the insurance company has no claim to it.

The downside is that withdrawals reduce your death benefit dollar-for-dollar. If your policy has a $500,000 death benefit and $150,000 in cash value, and you withdraw $50,000, your death benefit drops to $450,000. You also owe income tax on the withdrawal amount above your basis, as described above. And you lose the tax-deferred growth that the cash value would have earned inside the policy.

This strategy makes sense if you have more cash value than you need for insurance protection, or if you believe you can earn better returns investing the money yourself than the insurance company would earn for you. It does not make sense if you are trying to keep the death benefit intact for your beneficiaries.

When borrowing against life insurance makes sense

Policy loans are most useful when you need money at a lower rate than you could get elsewhere, and you plan to repay the loan. If you can borrow from a bank at 4 percent but your policy charges 6 percent, the bank is cheaper. But if your policy charges 5 percent and banks are quoting 8 or 9 percent, the policy loan is the better deal.

Policy loans also work well if you are between jobs or have poor credit and cannot get a traditional loan. The insurer does not check your credit or employment — they only care that you have cash value to borrow against. You can have the money in days.

The critical rule: only borrow if you have a realistic plan to repay. If you borrow $30,000 and never repay it, that $30,000 plus interest comes out of your death benefit. Your beneficiaries receive less, and if the loan grows large enough, the policy collapses and you lose all coverage. Borrowing works as a tool; borrowing as a permanent withdrawal in disguise is expensive and risky.

Frequently Asked Questions

Can I use my life insurance cash value to invest in stocks?

Not directly through the policy, unless you have a variable universal life policy that offers stock-based sub-accounts. With whole life or traditional universal life, the insurer invests the cash value and you receive whatever returns they earn. You can borrow against the cash value and invest the borrowed money in stocks yourself, but that is a loan you must repay.

What happens to my death benefit if I take a loan against my policy?

The death benefit is reduced by the unpaid loan balance plus accrued interest. If you borrow $40,000 and never repay it, your beneficiaries receive $40,000 less. If the loan grows larger than the cash value, the policy can lapse entirely and your beneficiaries receive nothing.

Is a policy loan better than withdrawing cash value?

A loan is better if you plan to repay it, because loans are not taxable and do not permanently reduce your death benefit (as long as you repay). Withdrawals are taxable on the amount above your premiums paid, and they permanently reduce the death benefit. But if you never repay the loan, it functions like a withdrawal anyway — your beneficiaries lose that money.

Can I lose my life insurance if I borrow too much?

Yes. If the loan balance grows too large relative to the cash value, the policy can lapse because there is not enough money to cover the monthly insurance costs. Once a policy lapses, it is gone — you lose all coverage and your beneficiaries receive nothing. This is more common with variable universal life policies, where a market downturn can shrink the cash value while the loan balance stays the same.

Do I owe taxes on a policy loan?

No. A loan is not taxable income because you borrowed money, not earned it. You only owe taxes if the loan is never repaid and the policy ends — then the forgiven debt is treated as taxable income in that year.