Can I Borrow From My Life Insurance Policy?

Certain types of life insurance policies offer a feature allowing policyholders to access accumulated funds during their lifetime. This mechanism, known as a life insurance policy loan, serves as a flexible financial resource. It allows individuals to leverage the value within their life insurance without fully surrendering the policy.

Understanding Life Insurance Policy Loans

A life insurance policy loan represents a loan taken directly from the insurance company, using the policy’s accumulated cash value as collateral. This differs significantly from a traditional loan obtained from a bank or other external lender. The funds for the loan do not actually leave the policy’s cash value; instead, the insurance company lends money from its general fund, with the policy’s cash value securing the loan. The cash value typically continues to grow, earning interest or dividends, even while a loan is outstanding.

Not all life insurance policies qualify for this loan feature. Only permanent life insurance policies, such as whole life, universal life, and variable universal life, accumulate cash value over time and therefore allow policy loans. Term life insurance policies, designed to provide coverage for a specific period, do not build cash value and consequently do not offer a loan option. It generally takes several years for a permanent policy to build sufficient cash value before a loan can be considered.

Approval for a life insurance policy loan is not contingent on the policyholder’s credit score, income, or employment history. Since the policy’s cash value acts as collateral, the loan process is typically simpler and does not involve extensive credit checks.

A policy loan differs from a cash value withdrawal. A loan is a debt that accrues interest and can be repaid, allowing the policy’s full value and death benefit to be restored. Conversely, a withdrawal permanently removes funds from the policy’s cash value, directly reducing both the cash value and the death benefit. While a withdrawal does not accrue interest, it permanently lessens the policy’s financial capacity.

Key Features of Policy Loans

The amount a policyholder can borrow is generally determined as a percentage of the accumulated cash value, often up to 90%. This maximum loan amount may also be influenced by any existing loans or outstanding premiums against the policy. The cash value must reach a certain level, which varies by insurer, before a loan becomes feasible.

Interest is applied to life insurance policy loans, similar to other forms of credit. The interest rate can be fixed or variable, depending on the specific policy terms. Unpaid interest typically accrues and is added to the principal loan balance, causing the total outstanding loan to grow over time. This compounding interest means that if payments are not made, the loan balance can increase significantly.

One notable characteristic of policy loans is their flexible repayment structure. Unlike conventional loans, there are often no mandatory repayment schedules or fixed monthly payments. Policyholders can choose to repay the loan in a lump sum, make partial payments, or even opt not to repay it at all during their lifetime.

While a loan is outstanding, the portion of the cash value used as collateral may not earn interest or dividends at the same rate as the unencumbered cash value. In some instances, the loaned portion may earn at a reduced rate or cease to earn altogether, which can impact the policy’s overall growth potential.

A direct consequence of an outstanding policy loan is its impact on the death benefit. Any unpaid loan balance, along with accrued and unpaid interest, will be deducted from the death benefit paid to beneficiaries upon the policyholder’s death. This reduction means beneficiaries will receive less than the policy’s face amount if the loan is not fully repaid.

Regarding taxation, life insurance policy loans are generally tax-free when received, as they are viewed by the IRS as an advance against the policy’s cash value, not as income. However, this tax-free status can change if the policy lapses or is surrendered with an outstanding loan. In such cases, the loan amount, specifically the portion exceeding the premiums paid (the cost basis), could become taxable income to the policyholder. This potential for a taxable event, sometimes referred to as “phantom income,” can arise if the loan balance and accrued interest exceed the policy’s cash value, leading to policy termination.

Requesting and Managing a Policy Loan

Initiating a life insurance policy loan typically involves directly contacting the insurance company. Policyholders can often submit a request through various channels, including phone, email, or by accessing an online policyholder portal. Many insurers provide specific loan request forms that need to be completed.

When requesting a loan, policyholders will generally need to provide essential information. This includes the policy number, the desired loan amount, and personal identification for verification purposes. The insurer will confirm the available cash value to determine the maximum loan amount that can be advanced.

Once the loan request is approved, the funds are typically disbursed to the policyholder through direct deposit to a bank account or by mailing a check. The timeframe for receiving funds can vary, but it is often a matter of days after approval.

Policyholders have various options for repaying the loan. Repayment can be made in a lump sum, through partial payments, or by establishing a schedule of regular payments. While there is often no strict repayment schedule, making repayments helps to restore the policy’s full cash value and death benefit. Unpaid interest is frequently added to the loan principal, increasing the total amount owed.

Regular policy statements or online portals provided by the insurer allow policyholders to track their outstanding loan balance and accrued interest. Staying informed about the loan status helps prevent the loan from growing to a point where it could negatively impact the policy.

A significant procedural consequence arises if the loan balance, including accrued interest, grows to exceed the policy’s available cash value. In such a scenario, the insurance company can terminate the policy to cover the outstanding loan. This lapse of the policy can trigger a taxable event, particularly if the outstanding loan amount exceeds the premiums paid into the policy. If the policy lapses, coverage ceases, and beneficiaries would not receive a death benefit.