Can I Borrow From My Supplemental Life Insurance?

Supplemental life insurance offers additional financial protection beyond a primary policy, often acquired through an employer or directly from an insurance provider. Some policies may offer living benefits, such as the ability to access funds during the policyholder’s lifetime through policy loans. This access depends on the specific features and structure of the insurance contract.

Eligibility for Policy Loans in Supplemental Coverage

The ability to borrow from supplemental life insurance depends on the policy type. Life insurance policies fall into two main categories: term life and permanent life insurance. Term life insurance provides coverage for a specific period and generally does not build cash value. This means term policies, including most employer-provided group term supplemental coverage, do not offer policy loans.

Permanent life insurance offers lifelong coverage and includes a cash value component that grows over time on a tax-deferred basis. This cash value is the foundation for accessing policy loans. Policies such as whole life and universal life are permanent and may allow policyholders to borrow against their accumulated cash value.

When supplemental life insurance is purchased individually, it often takes the form of a permanent policy, allowing for cash value accumulation and loan eligibility. Employer-sponsored supplemental plans vary; many are group term policies without a loan feature, but some employers offer voluntary permanent life insurance options that build cash value. The ability to borrow depends on the policy having a cash value component that reaches a sufficient level, which can take several years of premium payments.

The Mechanics of a Policy Loan

Taking a loan against a permanent supplemental life insurance policy involves a straightforward process, as the policy’s cash value serves as collateral. The loan is obtained directly from the insurance company, not a bank or traditional lender. This means there is typically no credit check, income verification, or lengthy approval process required.

To initiate a loan, a policyholder generally contacts their insurer or agent, or may use an online portal, to request funds. The amount available for borrowing is usually a percentage of the policy’s accumulated cash value, commonly up to 90%. This limit ensures that a portion of the cash value remains within the policy. Funds can typically be disbursed within a few days to a week, often via electronic transfer.

Policy loans accrue interest, similar to other forms of borrowing, with rates often more competitive than personal loans or credit cards, typically ranging from 5% to 8%. These interest rates can be fixed or variable, depending on the specific policy terms. Policy loans have a flexible repayment structure; there is generally no strict repayment schedule, and policyholders can choose to repay the loan in lump sums, periodic payments, or even not at all during their lifetime. However, interest continues to accrue on the outstanding balance.

Financial and Tax Implications of Policy Loans

While policy loans offer flexible access to funds, they carry financial and tax implications. Financially, any outstanding loan balance, along with accrued interest, will be deducted from the death benefit paid to beneficiaries when the insured passes away. This reduction can diminish the financial protection intended for loved ones.

An outstanding loan can also affect the policy’s cash value growth. The portion of the cash value used as collateral for the loan may continue to earn interest or dividends, but the loaned amount itself is no longer actively contributing to the policy’s overall growth. This can slow the accumulation of cash value over time. A risk arises if the loan balance, including accrued interest, grows to exceed the policy’s cash value. In such circumstances, the insurance company may surrender the policy to cover the loan, leading to a loss of coverage.

From a tax perspective, policy loans are generally not considered taxable income when taken, as they are viewed as a debt against the policy’s value. However, a taxable event can occur if the policy lapses or is surrendered while a loan is outstanding, and the loan amount exceeds the policy’s basis (the total premiums paid minus any dividends received). This can result in “phantom income,” where the policyholder owes taxes on gains even though they did not receive a direct cash payment. Interest paid on policy loans is typically not tax-deductible for individuals. It is advisable to consult with a tax professional for personalized guidance.