Aside from having a face value (the amount paid to beneficiaries upon death), a permanent life insurance policy also has a cash value, which is a savings account funded by a portion of the policy’s premiums. When policies are held long enough for their cash value to accrue to significant amounts, policyholders can use some of the cash without surrendering the policy. The simplest way to do so involves withdrawing the “basis,” which is the amount in the cash-value account that was paid by premiums. While this money can be withdrawn tax-free, any amount withdrawn that exceeds that amount (gains) will be taxed at the policyholder’s ordinary income rate. The death benefit is then reduced by the total amount withdrawn.
NOTE: For occasional cash loans, it is possible to borrow tax-free cash from a permanent life insurance policy, generally at market rates.