Can I Borrow From My Term Life Insurance Policy?

Generally, you cannot borrow from a term life insurance policy. This type of coverage is designed purely for a death benefit and does not accumulate a cash value component. However, other types of life insurance policies, known as permanent life insurance, do build a cash value over time. This accumulated cash value can be a source of funds that policyholders may access through a loan.

Understanding Term Life Insurance

Term life insurance provides coverage for a specific period, such as 10, 20, or 30 years. It functions much like a rental agreement for insurance, offering a death benefit to beneficiaries if the insured passes away within the specified term. This type of policy is structured to provide straightforward financial protection for a defined duration, making it a cost-effective option for many.

A fundamental characteristic of term life insurance is its lack of a cash value component. Premiums paid for term life insurance go solely towards funding the death benefit and administrative costs. Therefore, policyholders cannot borrow against a term life policy.

Permanent Life Insurance and Cash Value

In contrast to term life, permanent life insurance policies are designed to provide coverage for the insured’s entire life. This category includes types such as whole life and universal life insurance. A significant feature of these policies is their ability to build cash value over time.

A portion of the premiums paid into a permanent life insurance policy is allocated to this cash value component. This cash value grows on a tax-deferred basis, meaning earnings are not taxed until they are withdrawn. Policyholders can access this growing cash value through various methods while they are still alive.

Accessing Funds Through a Policy Loan

Policyholders with permanent life insurance can obtain a loan by borrowing against their accumulated cash value. This process does not involve a credit check, as the policy’s cash value serves as collateral for the loan. The loan is provided by the insurance company itself.

The amount available for a loan is generally limited to a percentage of the policy’s cash value, often up to 90%. While the loan is outstanding, the policy remains in force, continuing to provide its death benefit. It is important to understand that the loan is taken from the insurer, secured by the cash value, rather than being a direct withdrawal of the cash value itself.

Key Aspects of Policy Loans

Policy loans accrue interest, which must be paid to the insurer. While there is no strict repayment schedule, any unpaid interest will be added to the loan balance, causing it to grow over time.

An outstanding loan balance, including accrued interest, will reduce the death benefit paid to beneficiaries if the insured passes away before the loan is fully repaid. If the loan balance, along with its interest, grows to exceed the policy’s cash value, the policy could lapse, resulting in a loss of coverage. Should a policy lapse due to an unpaid loan, the outstanding loan amount may become taxable income to the policyholder.