Before you take money from a policy: a loan or withdrawal checklist

Taking money out of a permanent life insurance policy takes one form and a few days. Undoing a mistake can take years, and some mistakes cannot be undone at all. This checklist is the set of questions worth answering before you sign that form, grouped by what each group protects, with the reason each item matters. You can work through it alone with your latest statement, but several answers can only come from the insurer, so plan on one phone call and one written request.

How to use this checklist

Print or copy the groups below. For each item, write the answer next to it, and mark any item you cannot answer as "ask the insurer." A decision to borrow or withdraw is ready to make when no item is blank and none of the answers surprises you.

Two cautions first. This is a list of questions, not advice about which route to choose; the right answer depends on your policy type, tax situation and plans. And every number in the examples below is an invented illustration, not a price or a result for any policy. A tax professional or fee-only planner is the right person for the final call when the amounts are large.

If you want the background on how each route works before you start, read life insurance policy loans: how they work and what they risk for loans and withdrawing cash value from a life insurance policy for withdrawals. The difference in one sentence: a loan borrows the insurer's money against your cash value and leaves the value in place as collateral, while a withdrawal removes part of the value itself.

Group 1: Confirm what you are drawing on

The first mistake is borrowing against a number that is not what you think it is.

1. Which number is the available amount? Statements list several: the cash value, the cash surrender value (cash value less surrender charges), and the maximum loan or withdrawal. Ask which one the insurer will actually lend against or pay out. Reason: the figures can differ by thousands of dollars, especially in a young policy where surrender charges are still large.
2. How much of the value is guaranteed? The guaranteed values in the contract are the minimum. The rest of the total figure often comes from dividends or credited interest that the insurer can change, the non-guaranteed elements. See guaranteed vs non-guaranteed values in a policy illustration. Reason: if you plan around the total figure and the insurer later lowers its dividend scale or credited rate, your margin shrinks.
3. What does the in-force projection show after your draw? Ask for an how to request and read an in-force illustration that includes the planned loan or withdrawal and runs to a late age. Reason: it shows the year, if any, in which the policy can no longer support itself.
4. Is there a surrender charge on a withdrawal? Some contracts charge on withdrawals above a free amount during an early period. Reason: you may receive less than you asked for.
5. Who owns the policy? If someone else is the owner, only the owner can authorize the request, and a collateral assignment to a lender may block access without the lender's consent. Reason: a request that is rejected after weeks of waiting costs time you may not have.

Group 2: Know your basis and tax status

This group matters most because the answers decide whether money arrives tax-free.

1. What is my basis? Basis, also called investment in the contract, is generally the premiums you paid minus tax-free amounts you already received. See cost basis. Reason: for an ordinary policy, withdrawals are generally tax-free up to basis and taxable above it, as explained in how cash value is taxed: withdrawals, loans and surrenders.
2. Is the policy a modified endowment contract? A modified endowment contracts and the 7-pay test (MEC) is a policy funded faster than the seven-pay test allows. Loans and withdrawals from a MEC are taxed gains-first, and a 10% additional tax generally applies before age 59½. Ask the insurer in writing whether the policy has MEC status. Reason: the same $25,000 can be tax-free from one policy and mostly taxable from another. If the answer turns out to be yes, read Your policy turned out to be a MEC: what it means and what you can do before you proceed.
3. Have I taken other distributions? Earlier withdrawals, dividends taken in cash and loans that were forgiven can all reduce basis or count toward gain. Reason: the insurer's basis figure and yours may differ.
4. Is the policy in its first 15 years? A withdrawal that reduces the death benefit in the early years can be taxed on a gain-first basis under a special rule in the tax code, even for a policy that is not a MEC. Ask the insurer whether it applies. Reason: the usual "basis first" treatment may not hold for a young policy.
5. Will the insurer report anything to the IRS? Taxable distributions are reported on Form 1099-R. Ask what the insurer expects to report. Reason: you want no surprises at tax time, and the amount reported can be questioned if you think it is wrong.

Group 3: What the draw does to the death benefit

1. Does the death benefit fall dollar for dollar? An unpaid loan is subtracted from the death benefit at death, with accrued interest. A withdrawal may reduce the face amount or the death benefit, depending on the policy type and death benefit option. Reason: the family's protection becomes smaller, sometimes much smaller.
2. Is the remaining benefit still enough for the original purpose? Look at who depends on the policy and what the death benefit was meant to cover. Reason: a policy bought to protect a mortgage or a child's future has a purpose that does not shrink because you needed cash.
3. Does a smaller death benefit change the policy's tax qualification? The tax code requires a minimum ratio of death benefit to cash value (the corridor). A withdrawal in a flexible policy can interact with this. Reason: the insurer should handle it, but you want to know whether the withdrawal triggers a reduction you did not expect.
4. Do any riders end or change? Some riders have charges tied to the face amount or end if the policy is reduced. Reason: a benefit you value may disappear.

Group 4: Loan terms (if you are borrowing)

1. Is the interest rate fixed or variable, and what is the cap? Variable rates can change; some contracts guarantee a maximum. Reason: a rate you cannot predict makes planning harder. fixed, variable and wash loans compared: what borrowing costs net compares the structures.
2. When is interest due and how is it charged? Annual interest due on each anniversary is common. Reason: if you do not pay it, it is added to the loan balance and starts compounding. The policy loan interest entry explains the mechanics.
3. How does the borrowed portion of the cash value behave? Some companies adjust dividends or credited interest on loaned values (direct recognition), and others do not. See direct and non-direct recognition loans: how borrowing affects dividends. Reason: this decides the true net cost of the loan, which is not the stated loan rate alone.
4. Is there a loan fee or a minimum loan? Reason: small loans can cost proportionally more.
5. What happens if the loan reaches the cash value? Ask for the policy's rule and the notice period before it terminates. Reason: you want to know the exact consequence, which for a large loan is a lapse and a possible tax bill.

Group 5: A repayment plan you can write down

1. Will I pay interest each year, pay principal, or neither? Write the answer. Reason: "I'll deal with it later" is the plan that most often fails. Use the worksheet in policy loan worksheet: interest, repayments and what the policy can carry to see what each plan does to the balance.
2. What happens to the plan if I lose income? Reason: a loan taken for an emergency should not become a second emergency.
3. When will I recheck? Put a date on the calendar at the next policy anniversary. Reason: the statement shows loan balance and cash value together; a trend is more useful than a single reading.
4. Is there a cheaper way to raise the cash? Compare a bank loan, a home equity line, a hardship option or a smaller draw. The policy loan calculator shows the policy side of the comparison. Reason: a policy loan has no credit check and no set repayment date, which are advantages, but it uses a long-term asset to pay for a short-term need.

Group 6: Dividends and other features that interact

1. Do I have paid-up additions or a dividend accumulation I could use instead? In a participating whole life policy, dividends left on deposit or used to buy paid-up additions are sometimes the first and simplest source. Ask how withdrawal from each is taxed and whether it affects guarantees. Reason: taking dividend values may leave the main policy's guarantees untouched.
2. Will a draw affect an automatic premium loan or a premium-offset arrangement? Reason: if dividends are paying part of your premium, reducing them can bring a premium bill back.
3. Is there an overloan protection rider? Reason: knowing whether one exists changes the worst case, though it is no substitute for a plan.

Group 7: Paperwork and proof

1. Get the figures in writing before you sign. Ask the insurer to confirm in writing the amount you will receive, the effect on the death benefit, the MEC status, your basis and, for a loan, the rate and the maximum. Reason: a phone answer is hard to cite later.
2. Read the request form for the type. Loan and withdrawal forms look alike. Reason: ticking the wrong box turns a loan into a withdrawal, which changes the tax and the death benefit.
3. Keep a copy of every confirmation and each year's loan statement. Reason: if the policy ends while a loan is outstanding, you will need the basis and loan history to prepare your tax return.

A short script for the call

Phone calls to a service center go better with a script, because the person on the line may not volunteer what you did not ask. A reasonable order:

1. State the policy number and say you are considering a loan or withdrawal of a specific amount, not that you want to "access your cash."
2. Ask for the current cash value, cash surrender value, outstanding loans and the maximum available.
3. Ask for your basis and whether the policy is a MEC, and ask that both be confirmed in writing.
4. Ask what happens to the death benefit under each route, and what the policy projects after the draw.
5. For a loan, ask for the rate, the interest due date and the treatment of the borrowed portion.
6. Ask for the name or reference number of the person you spoke with, and the date the written confirmation will arrive.

If the representative cannot answer the tax questions, that is normal: service staff generally explain the insurer's own records, not your personal tax result. Ask them to put the records in writing and take them to a tax professional.

Worked example: the same $25,000 three ways

These figures are invented. Say Dana owns an ordinary whole life policy with a cash surrender value of $70,000, basis of $40,000 and a $200,000 death benefit. She needs $25,000. She is 48.

Notice what the table does not say. It does not say which route is better. It shows that the MEC question in item 7 can turn a no-tax result into a $25,000 income-tax event plus a $2,500 additional tax. It also shows that a withdrawal uses up basis, so a later withdrawal of another $25,000 would put $10,000 above basis into taxable territory. The checklist exists to bring such facts to the surface first.

When to stop and ask for help

Pause the request if you notice any of these:

• The insurer cannot or will not say in writing whether the policy is a MEC.
• The amount is large relative to the cash value, or the projection shows a lapse within your lifetime.
• A salesperson suggested the draw as part of buying another product. Replacement and "fund it with your policy" pitches deserve a second opinion; see using cash value in a financial emergency: the order to try things for the order in which to try alternatives.
• You are being rushed, or told a loan "never has to be repaid" without hearing about the lapse consequences.

The state insurance department can help with a dispute about what the insurer told you, and a tax professional can confirm the tax treatment before you act.

Key takeaways

• A loan keeps the cash value in place as collateral and reduces the death benefit by the unpaid balance; a withdrawal removes value and may reduce the death benefit and the basis.
• MEC status and basis decide whether money arrives tax-free, so get both in writing before you sign.
• The stated loan rate is not the full cost; ask how dividends or credited interest change on the borrowed portion.
• Write down a repayment plan and a recheck date, because an unpaid loan keeps growing.
• Ask the insurer for confirmation of amounts, rates and effects in writing, and keep every statement for tax time.