By Marc Gilman
Questions? Call (800) 927-9326 or email
Key Takeaways
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A permanent life insurance policy can shift roles over time. If the death benefit is no longer your top priority, the cash value behind it can become a source of retirement income.
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There isn’t one way to access that cash value — there are at least six, and each comes with its own tax treatment, risks, and best-fit situation.
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The biggest danger across nearly every strategy is the same: an unintended lapse. Take out too much, and a policy can lapse with an unexpected tax bill attached — sometimes on money you took out years earlier.
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A 1035 exchange lets you move cash value into an annuity or a hybrid long-term care policy without triggering taxes on the gain — useful once the original death-benefit need has changed.
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None of these strategies replace a full financial review. Whether any of them make sense depends on your full retirement picture, not the policy in isolation.
Why a Life Insurance Policy’s Role Can Change
Life insurance is usually bought to solve a specific problem — replacing income for dependents, covering a mortgage, funding a business buy-sell agreement. Those needs can fade over time. Kids become financially independent, a mortgage gets paid off, a business gets sold. When that happens, a permanent policy with built-up cash value doesn’t have to just sit there. It can become a supplemental source of retirement income, on top of Social Security, pensions, and retirement accounts.
The question isn’t whether cash value can be accessed — it’s which method fits the situation, since each comes with different tax rules and different risks to the policy itself.
The Six Ways to Turn Cash Value Into Income
Policy withdrawals. The most direct approach: withdraw cash value as needed. Amounts up to what you’ve paid in premiums (your basis) come out tax-free; anything beyond that is taxable income. Withdrawals permanently reduce both the cash value and the death benefit, and a policy purchased in the last 10–15 years may carry surrender charges that cut into what’s actually available.
Policy loans. Most carriers let you borrow against 90% or more of your cash value, with no credit check and no requirement to pay it back. Interest accrues the entire time the loan is outstanding. If you die with a balance owed, it’s simply subtracted from the (still tax-free) death benefit. Loans can be a useful alternative to selling investments during a market downturn — since a whole life policy’s cash value isn’t tied to market performance the way a brokerage account is, a policy loan lets other assets recover before you draw on them.
A Life Insurance Retirement Plan (LIRP). This is a deliberate strategy, not just a feature: you overfund a permanent policy well beyond the minimum premium to build a larger cash value, then in retirement take tax-free withdrawals up to basis, followed by tax-free policy loans. It’s typically considered only after 401(k)s, IRAs, and other retirement accounts are already maxed out, since you’re paying for insurance coverage on top of building savings. The tradeoff: take too much out and the policy can lapse, triggering what’s sometimes called “phantom” tax — owing tax on the policy’s gain even though you may not have touched the cash value in years.
Dividends paid in cash. Some whole life policies pay annual dividends, and many participating carriers have done so for over a century — though dividends are never guaranteed. Taken in cash rather than reinvested, dividends reduce the policy’s cost basis dollar-for-dollar and generally aren’t taxable until basis reaches zero. The catch: because dividends fluctuate and aren’t guaranteed, they’re not something to count on for a fixed annual income need.
A 1035 exchange into an annuity. This lets you move cash value from a life insurance policy into an annuity without surrendering the policy and paying tax on the gain first — a tax-free transfer under Internal Revenue Code Section 1035. It fits a specific situation: no longer needing the death benefit, but wanting guaranteed lifetime income instead. Once annuitized, a portion of each payout is a tax-free return of premium and a portion is taxable, spreading the tax impact across your expected lifetime rather than hitting all at once. The tradeoff is permanence — once you annuitize, you generally can’t change your mind and access the money as a lump sum again.
A 1035 exchange into a hybrid life/long-term care policy. This one doesn’t generate retirement income — it redirects cash value toward protection against long-term care costs. If you end up needing care, the hybrid policy’s LTC benefit pays out (typically triggered by needing help with two of six activities of daily living, or a severe cognitive impairment); if you don’t, your beneficiaries still receive a death benefit. Done through a 1035 exchange, the transfer itself doesn’t trigger taxes, and qualified LTC payouts aren’t taxable either.
Mistakes Worth Avoiding
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Treating a policy loan like free money. Interest accrues the whole time, and it compounds against the cash value that’s collateralizing the loan.
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Taking withdrawals or loans without checking basis first. Anything above what you’ve paid in premiums is taxable — a distinction that’s easy to overlook mid-withdrawal.
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Letting a policy drift toward lapse. This is the single costliest mistake across every strategy above: a lapsed policy with an outstanding loan or withdrawal history can create a tax bill on money that was taken out years earlier.
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Counting on dividends as guaranteed income. They’ve been paid consistently by some carriers for well over a century, but “usually” isn’t “guaranteed,” and amounts vary year to year.
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Annuitizing before being sure. A 1035 exchange into an immediate annuity is generally a one-way door — there’s no going back to a lump sum afterward.
Who Should Actually Consider This
This isn’t a strategy for everyone with a life insurance policy — it fits a fairly specific set of circumstances:
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The original death-benefit need has genuinely changed, and beneficiaries no longer depend on the full payout.
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Meaningful cash value has already built up in the policy.
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Other tax-advantaged retirement accounts — 401(k), IRA — are already maxed out, and this is an additional lever, not a replacement for those.
Questions Worth Asking
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Has your need for the death benefit actually changed, or does it still matter to the people who’d receive it?
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Do you know your policy’s current basis — and how close a withdrawal or loan would come to exceeding it?
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If you’re considering a policy loan, do you have a plan to pay it back, or a clear picture of how an outstanding balance affects the death benefit?
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Have you requested an in-force illustration recently to see how loans or withdrawals are actually affecting your cash value and lapse risk?
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If a 1035 exchange is on the table, are you confident enough in that decision to give up the ability to change your mind later?
What To Do Next
If you’re holding a permanent life insurance policy and wondering whether it could do more for you in retirement than sit as a death benefit, let’s look at what your specific policy actually supports — including an in-force illustration so you can see the real numbers, not just the general strategy.
Questions? Call (800) 927-9326 or email
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Sources: Kimberly Lankford, “6 Ways Life Insurance Can Create Retirement Income,” Buy Side from WSJ / USA Today (updated September 15, 2026), with commentary from Ramon Casanova (New York Life), Steve Parrish (The American College of Financial Services), Jason Asaro (MassMutual), and Donna Skeels Cygan, CFP.
This article is for general educational purposes and is not personalized financial, tax, or legal advice. Tax treatment of life insurance withdrawals, loans, dividends, and 1035 exchanges depends on your specific policy and circumstances — consult a qualified tax advisor before acting. This is not a recommendation regarding any specific product. Consult a licensed advisor for guidance specific to your situation.
