Can I Borrow From My Term Life Insurance?

Many individuals wonder if their life insurance policy can serve as a source of funds during their lifetime. This article aims to clarify whether borrowing is an option with term life insurance and to distinguish it from policies that do allow such access.

Understanding Term Life Insurance and Cash Value

Term life insurance provides coverage for a specific period, such as 10, 20, or 30 years. It is designed to offer a death benefit to beneficiaries if the insured person passes away within that defined term. This type of policy is often chosen for its affordability and its clear purpose of providing financial protection for a set duration.

A defining characteristic of term life insurance is its lack of a cash value component. Unlike other types of life insurance, term policies are pure protection and do not accumulate an internal savings or investment element. Therefore, because there is no cash value built within a term life insurance policy, there is no accumulated fund from which a policyholder can borrow.

Policies That Allow Borrowing

Certain types of life insurance policies, known as permanent life insurance, do allow for borrowing because they include a cash value component. Policies such as whole life insurance and universal life insurance build cash value over time. This cash value is a portion of the premiums paid that accumulates on a tax-deferred basis, growing through interest or dividends.

When a policyholder borrows from a permanent life insurance policy, they are taking a loan against the accumulated cash value, using it as collateral. This is not a withdrawal of the cash value itself, so the policy generally remains in force. Interest is charged on these policy loans, with rates often ranging between 5% and 8%. If the loan and accrued interest are not repaid, the outstanding balance will reduce the death benefit paid to beneficiaries upon the insured’s passing. Policy loans are not considered taxable income unless the policy lapses or is surrendered with an outstanding loan, and the loan amount exceeds the premiums paid.

Converting Term to Permanent Coverage

Many term life insurance policies offer convertibility, which allows the policyholder to convert their term coverage into a permanent life insurance policy. This conversion can be done without a new medical examination, even if the insured’s health has changed. This is a valuable option for individuals whose financial needs evolve and who desire cash value accumulation and borrowing capabilities of a permanent policy.

When converting, premiums for the new permanent policy will be higher than for the original term policy. This increase reflects lifelong coverage and the new cash value component, and the premium is calculated based on the insured’s age at conversion. Most term policies specify a conversion period, often within the first 5 to 10 years of the policy’s term. The conversion process allows the policyholder to transition to a product that builds accessible cash value, opening the possibility of policy loans.