Can I Borrow Money From Life Insurance?

Life insurance provides a death benefit to beneficiaries upon the policyholder’s passing. Beyond this, certain types of life insurance policies can offer financial utility during the policyholder’s lifetime. These policies accumulate a cash value component, which may be accessed through loans. This allows policyholders to leverage their insurance as a financial resource, providing a flexible option for accessing funds without disrupting the policy’s death benefit, provided certain conditions are met.

Identifying Eligible Life Insurance Policies

The ability to borrow from a life insurance policy hinges on the presence of a “cash value” component. Cash value refers to a savings feature embedded within certain permanent life insurance policies, where a portion of each premium payment is allocated to an account that grows over time. This accumulated cash value can then be accessed by the policyholder.

Term life insurance policies typically do not build cash value, and therefore, they do not allow policyholders to borrow against them. In contrast, permanent life insurance policies provide lifelong coverage and inherently include a cash value component. Key examples of permanent life insurance that accumulate cash value and permit loans include Whole Life and Universal Life insurance. Whole Life policies generally grow their cash value at a fixed interest rate, offering guaranteed growth, while Universal Life policies may have cash value growth tied to market performance or an equity index, often with a guaranteed minimum rate. It often takes several years of premium payments for a policy to accumulate sufficient cash value to support a loan.

Understanding Life Insurance Loan Mechanics

A life insurance policy loan is not a direct withdrawal of the cash value, but rather a loan provided by the insurance company, with the policy’s accumulated cash value serving as collateral. The policy remains in force, and the cash value continues to grow, even with an outstanding loan. Since the loan is secured by the policy’s cash value, a credit check is generally not required, and there is no lengthy application process.

Interest accrues on the outstanding loan balance, similar to other types of loans. Interest rates for life insurance loans are typically competitive, often ranging from 5% to 8%, which can be lower than rates for personal loans or credit cards. If the loan is not repaid, any outstanding loan amount, including accrued interest, will reduce the death benefit paid to beneficiaries. For instance, if a policy has a $250,000 death benefit and an outstanding loan of $50,000, the beneficiaries would receive $200,000.

Policy loans are generally not considered taxable income as long as the policy remains in force, because they are viewed as a debt rather than income.

The Process of Obtaining a Loan

Initiating a life insurance policy loan involves a straightforward process. Policyholders typically contact their insurer to request a loan once sufficient cash value has accumulated. The insurance company will provide the necessary forms or instructions to complete the loan request.

Once the request is submitted, processing time for a life insurance loan is often relatively quick. Funds are typically disbursed within a few days. The policyholder can use the funds for any purpose, as there are generally no restrictions. The amount available for borrowing is typically limited to a certain percentage of the cash value, often up to 90%.

Managing and Repaying the Loan

Managing an active life insurance loan involves understanding the repayment options and the implications of non-repayment. Policy loans often offer significant flexibility, as there is typically no fixed repayment schedule. Policyholders may choose to repay the loan in a lump sum, make periodic payments, pay only the interest, or even allow the interest to accrue and be added to the loan balance. However, allowing interest to accumulate will increase the total outstanding loan amount.

A substantial risk arises if the outstanding loan balance, including accumulated interest, exceeds the policy’s cash value. In such a scenario, the policy could lapse, leading to the loss of coverage. If a policy lapses with an outstanding loan, the loan amount exceeding the policy’s cost basis (premiums paid minus dividends received) can be treated as taxable income by the IRS. This can result in an unexpected tax liability for the policyholder.