Can I Borrow Against My Death Benefit?
Learn if and how your life insurance policy can provide financial access during your lifetime, including key considerations and potential impacts.
Life insurance is primarily designed to provide a financial safety net for your beneficiaries after you pass away, delivering a sum of money known as a death benefit. This payout helps your loved ones manage financial obligations, replace lost income, or cover final expenses. While the death benefit is the central feature of these policies, it is possible, under specific circumstances and with certain policies, to access funds from a life insurance policy during your lifetime. This ability to tap into your policy’s value can offer a flexible financial resource for various needs.
Understanding Policy Cash Value
The ability to access funds from a life insurance policy while living stems from cash value. This feature is exclusive to permanent life insurance policies, such as whole life, universal life, variable universal life, and indexed universal life. A portion of premiums contributes to this cash value, which grows over time. Its growth is tax-deferred, meaning you do not pay taxes on earnings as they accumulate.
As the policy matures, cash value increases, distinct from the death benefit paid to beneficiaries upon the insured’s passing. While the death benefit is the primary purpose, cash value acts as a savings component accessible by the policyholder. This cash value can also serve as collateral for loans. Term life insurance policies, which provide coverage for a specific period, do not build cash value and therefore do not offer this option.
Accessing Funds Through Your Policy
Policyholders with cash value life insurance can access their funds through several methods: a policy loan, a cash value withdrawal, or accelerated death benefits under specific qualifying conditions. Each option functions differently and carries distinct implications.
A policy loan is a loan from the insurer, using the policy’s cash value as collateral. Unlike a traditional bank loan, no credit checks are required, and repayment schedules are flexible; you are not obligated to repay on a strict timeline. Interest is charged on these loans, with rates ranging from 5% to 8%, accruing over time. If the loan and accrued interest are not repaid, the outstanding balance reduces the death benefit paid to beneficiaries.
A cash value withdrawal involves directly taking money from the policy’s cash value. Unlike a loan, a withdrawal permanently reduces both the cash value and the death benefit. Policy terms include limits on how much can be withdrawn to prevent the policy from lapsing due to insufficient funds. This option removes the funds directly from the policy.
Accelerated Death Benefits (ADBs), also known as living benefits, are provisions allowing access to a portion of the death benefit before death. These benefits are available under specific qualifying circumstances, such as a diagnosis of a terminal illness with a limited life expectancy, or a chronic or critical illness. This is an advance on the death benefit, and the amount accessed is directly deducted from the total death benefit. Eligibility for ADBs varies by policy and insurer, requiring medical documentation to confirm the qualifying condition.
Financial Implications of Accessing Funds
Accessing funds from a life insurance policy carries several financial consequences that policyholders should carefully consider. The most direct impact is on the death benefit, the amount intended for beneficiaries. For policy loans, any outstanding loan balance, with accrued interest, will be subtracted from the death benefit, resulting in a reduced payout. Cash value withdrawals permanently decrease both the policy’s cash value and the death benefit. Accelerated death benefits also reduce the death benefit by the amount advanced.
A significant risk with policy loans is the potential for policy lapse. If an unpaid policy loan, plus accumulating interest, exceeds the policy’s cash value, the policy can terminate without further premium payments. This results in loss of coverage and any remaining policy value. While repayment is flexible, failure to manage accruing interest can lead to this outcome.
The tax implications of accessing funds vary by method. Policy loans are generally considered debt, not income, and are typically tax-free as long as the policy remains in force and is not a Modified Endowment Contract (MEC). However, if a policy lapses or is surrendered with an outstanding loan, the loan amount exceeding premiums paid (cost basis) can become taxable income. For cash value withdrawals, amounts are generally tax-free up to the policyholder’s cost basis (total premiums paid). Any withdrawals exceeding this cost basis are typically taxable as ordinary income. Accelerated death benefits are generally excluded from federal income taxation under current tax laws, provided they meet specific criteria for terminal or chronic illness.
Finally, accessing funds reduces the policy’s surrender value, which is the amount you would receive if you were to terminate the policy. This reduction occurs because accessed funds diminish the available cash value. Understanding these financial consequences is important for making informed decisions about utilizing your policy’s living benefits.
Steps to Access Policy Funds
Initiating the process to access funds from a life insurance policy involves a series of steps. First, a policyholder should review their specific policy documents. These documents contain detailed provisions regarding policy loans, cash value withdrawals, or accelerated death benefits, as terms vary significantly between policies and insurers. Understanding these terms clarifies eligibility and potential limitations.
The policyholder should contact their life insurance company directly or their financial advisor or insurance agent. This contact confirms available options, discusses specific policy requirements, and obtains necessary forms. The insurer or agent guides you through the initial inquiry and provides relevant information.
The insurer requires specific information and documentation to process the request. This may include the policy number, desired amount, and for accelerated death benefits, medical documentation confirming the qualifying illness. Completing required forms accurately and providing all requested supporting documents are important steps in the application process.
Once the application and documentation are submitted, the insurer begins processing the request. Processing time varies depending on the type of access requested; for policy loans, funds are disbursed within 5 to 7 business days. Upon approval, funds are disbursed via direct deposit or check, as specified by the policyholder and insurer’s procedures.