Can I Borrow From Whole Life Insurance?

Whole life insurance policies offer lifelong coverage and accumulate cash value over time. This cash value can serve as a valuable financial resource during the policyholder’s lifetime. One way to access these funds is by taking a policy loan. Unlike a withdrawal, which directly reduces the policy’s cash value, a policy loan is essentially borrowing money from the insurer, with the policy’s cash value serving as collateral.

Understanding Whole Life Policy Loans

A whole life policy loan originates from the insurance company, not directly from the policyholder’s accumulated cash value. Instead, the cash value acts as collateral, securing the loan provided by the insurer. This means the policy remains in force, and the unencumbered portion of the cash value continues to grow and earn interest or dividends.

Policy loans differ significantly from withdrawals. While a withdrawal permanently removes funds from the policy’s cash value and reduces the death benefit dollar-for-dollar, a loan creates a debt against the policy.

Interest accrues on the outstanding loan balance, typically as simple interest, with rates often ranging from 5% to 8%. These rates can be fixed or variable depending on the insurer and policy terms. This interest is paid back to the insurance company, not reinvested into the policy’s cash value.

Whole life policy loans are generally non-taxable. As debt, the funds received are typically not treated as taxable income, provided the policy remains in force.

An exception exists for policies classified as Modified Endowment Contracts (MECs). An MEC is a life insurance policy that has received premiums exceeding specific IRS limits. If a policy becomes an MEC, any loans, withdrawals, or distributions are treated differently for tax purposes. Gains are taxed first as ordinary income, and a 10% penalty may apply if the policyholder is under age 59½.

Policy loans generally do not require a credit check. Because the loan is secured by the policy’s cash value, the insurer does not need to assess the policyholder’s creditworthiness. This makes policy loans a readily accessible source of funds, without impacting one’s credit score, as they are not reported to credit bureaus.

Requesting a Policy Loan

Initiating a whole life policy loan involves confirming eligibility and providing necessary information to the insurer. The amount available for a loan is directly tied to the policy’s cash value, with most insurers allowing policyholders to borrow up to 90% of the accumulated cash value. Building sufficient cash value to borrow against can take several years, often ranging from 2 to 10 years, depending on the policy and premium payments.

To request a loan, policyholders typically need to provide their policy number and specify the desired loan amount. For direct deposit, banking details such as the bank name, account number, and routing number are essential for fund disbursement. While some insurers might inquire about the reason for the loan, the loan is collateralized by the policy’s own value.

Policyholders have several methods for submitting a loan request:
Online portals allow electronic submission.
Customer service can be contacted via phone.
Official loan request forms can be obtained from the insurer’s website or by mail, completed, and sent back via mail, fax, or email.

Once the request is submitted, the processing time for a policy loan is generally efficient. Funds are often disbursed within a few business days when direct deposit is utilized. If a physical check is requested, it may take one to two weeks to arrive by mail.

Implications and Repayment of Policy Loans

An outstanding policy loan has several financial implications. The loan reduces the accessible cash value, meaning that while the policy’s total cash value may continue to grow, the portion available for future loans or withdrawals is diminished by the outstanding loan balance. The unencumbered portion of the cash value continues to earn interest or dividends.

A loan directly impacts the policy’s death benefit. Any outstanding loan balance, along with accrued interest, will be deducted from the death benefit paid to beneficiaries upon the policyholder’s death. For participating whole life policies, an outstanding loan may affect dividend payments, as dividends might be reduced on the portion of the cash value used as collateral for the loan.

Whole life policy loans offer flexible repayment terms. Repayment is typically optional, meaning policyholders are not bound by a strict repayment schedule like with traditional bank loans. Policyholders can choose to:
Repay the loan in a lump sum.
Make partial payments.
Establish regular scheduled payments.
Opt not to repay the principal at all during their lifetime.

While principal repayment is flexible, interest on the loan continues to accrue. Policyholders can choose to pay the interest periodically, or if unpaid, the accrued interest may be added to the outstanding loan principal, causing the loan balance to grow. Repayments can generally be made through:
The insurer’s online payment portals.
Mailing a check.
Setting up automated deductions.

Choosing not to repay a policy loan carries direct financial outcomes. If the loan and its accrued interest are never repaid, the outstanding balance will continue to increase. This escalating loan balance can eventually erode the policy’s cash value to the point where the outstanding loan plus interest exceeds the remaining cash value. If this occurs, the policy could lapse, leading to the termination of coverage. A policy lapse with an outstanding loan can trigger significant tax implications, as the amount of the loan that exceeds the premiums paid may be considered taxable income, and a Form 1099-R may be issued by the insurer.