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Are withdrawals from a variable life policy tax-free?

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Variable life insurance is a former of permanent life insurance that lets you invest premiums in investment accounts. By doing so, your policy builds cash value. 

With cash value, you can tap into the money while you're alive if needed. It's not wise to dip too much into the policy. Money that you take from the policy's cash value means your loved ones will receive a smaller death benefit when you die. 

Cash value is part of other types of permanent life insurance, such as whole life. One difference with variable life insurance is that your policy's cash value grows quicker if your investments perform well. If they don't, you cash value decreases. 

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 don't pay taxes, you might pay a surrender fee if you withdraw money from the policy. A withdrawal would decrease or eliminate the death benefit, depending on the policy and how much money you take out of it. That's why it's critical that you understand your policy before tapping into cash value. 

Taking out a loan

Another option is to take out a loan against the policy's cash value. 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 shouldn't be considered a retirement investment. Why? 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. You should work with a competent adviser you trust before purchasing. Make sure you understand how a policy works. 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?"