Can I Borrow From My Life Insurance?

It is possible to access funds from certain types of life insurance policies through a policy loan. These loans allow policyholders to tap into the accumulated value within their policies, providing a source of funds for various financial needs. This option is available only with specific policy structures that build a cash value component over time.

Eligibility for Policy Loans

Accessing a policy loan is contingent upon owning a life insurance policy that has a cash value component. Permanent life insurance policies, such as whole life insurance and universal life insurance, are designed to accumulate cash value over the policy’s lifetime. As premiums are paid, a portion of each payment contributes to this cash value, which grows on a tax-deferred basis.

Unlike permanent policies, term life insurance policies do not build cash value. Term insurance is designed to provide coverage for a specific period, typically 10 to 30 years, and its primary function is to offer a death benefit if the insured passes away within that term. To be eligible for a loan, a permanent policy must have accrued sufficient cash value, which can take several years after the policy is issued. The specific amount of cash value required to qualify for a loan can vary by insurer.

Mechanics of a Policy Loan

A life insurance policy loan is not a withdrawal of your own money from the policy’s cash value. Instead, it is a loan provided by the insurance company, using your policy’s cash value as collateral. This means the cash value continues to grow within the policy, even while a loan is outstanding.

Interest is charged on the outstanding loan balance, similar to other types of loans. Interest rates for policy loans are typically lower than those for personal loans or credit cards, often ranging from approximately 5% to 8%. These rates can be fixed or variable, depending on the terms of the policy and the insurer. The interest accrues on the unpaid balance, and if not paid, it can be added to the outstanding loan principal, causing the loan balance to grow.

There is generally no fixed repayment schedule, meaning policyholders can repay the loan at their own pace or choose not to repay it at all. While repayment is not mandatory, any outstanding loan balance, including accrued interest, will reduce the death benefit paid to beneficiaries.

From a tax perspective, policy loans are generally considered tax-free because they are treated as a debt rather than income. This tax-free status holds as long as the policy remains in force. However, if the policy lapses or is surrendered with an outstanding loan, and the loan amount plus any other distributions exceeds the policy’s basis (the total premiums paid), the difference can become taxable income.

Furthermore, if a policy is classified as a Modified Endowment Contract (MEC) due to excessive premium payments within a certain period, loans from such policies are treated differently for tax purposes. For MECs, loans are taxed on a Last-In, First-Out (LIFO) basis, meaning earnings are considered withdrawn first and are immediately taxable. Additionally, a 10% penalty tax may apply if the policyholder is under age 59½. It is important to monitor the loan balance relative to the policy’s cash value to prevent a lapse, which could trigger a significant tax liability.

Requesting a Policy Loan

Initiating a policy loan typically involves contacting the insurance company directly. Policyholders can usually begin the process by calling the insurer’s customer service, accessing an online policy portal, or submitting a specific loan request form. Many insurers offer online access that allows policyholders to check their available cash value and initiate a loan request electronically.

During the loan request, policyholders will need to provide basic information. This generally includes the policy number, the desired loan amount, and the preferred method for receiving the funds. Some insurers may require banking information, such as a voided check or an Electronic Funds Transfer (EFT) form, for direct deposit. Other options for fund disbursement may include receiving a physical check by mail or a wire transfer, though wire fees might apply.

Once the loan request is submitted, the insurance company will process it. The processing time for a life insurance policy loan is generally quick, often taking approximately one week. Since the policy’s cash value serves as collateral, there is typically no credit check or extensive approval process involved. Policyholders can expect to receive confirmation of the loan and details regarding the outstanding balance and accrued interest after the funds are disbursed.