Are withdrawals from a variable life policy tax-free?

Variable life insurance is a type of permanent policy that lets you invest policy premiums in investment accounts to build cash value. If the investments do well, the policy's cash value grows faster than it would with a traditional type of permanent insurance policy. But the cash value could decrease if the investments tank.

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Not all life insurance policies allow you to make withdrawals from the policy's cash value. If a withdrawal is allowed, the money you take out is tax-free up to the basis – the amount of premiums you paid. You pay taxes on any withdrawal amount that exceeds the premium total.

But even if you pay no taxes, you might pay a surrender fee if you withdraw money from the policy. A withdrawal would also decrease or eliminate the death benefit, depending on the policy and how much money you take out of it.

Taking out a loan

Another option is to take out a loan against the cash value of the policy. You pay interest on the loan, and the policy's cash value serves as collateral. You must repay the money, plus interest, to keep the policy in force. You don't pay a surrender fee or taxes on the loan as long as you pay back the money.

Although cash value is a strong selling point of permanent life insurance, experts say it should not be considered a retirement investment because withdrawals reduce the death benefit and hurt the future financial security of the beneficiaries you're trying to protect.

Variable life insurance policies are complex, and you should work with a competent adviser you trust before purchasing. Make sure you understand how a policy works, and compare it to other alternatives. If you already own variable life insurance, check the policy for details about fees, loans and withdrawals.

For more, see "Term life insurance vs. permanent life insurance: Is cash value the best value?"