Can I Borrow Money From My Term Life Insurance?

Pure term life insurance policies do not allow you to borrow money. These policies are designed strictly to provide a death benefit for a specific period and do not accumulate any cash value. The ability to borrow from a life insurance policy is directly linked to the presence of an accumulated cash value, which serves as collateral for a loan.

Understanding Term Life Insurance

Term life insurance provides coverage for a defined period, such as 10, 20, or 30 years. It is a straightforward form of life insurance, providing a death benefit to beneficiaries if the insured person passes away within the specified term. This type of policy offers temporary financial protection, aligning with specific life stages or financial obligations.

Term life insurance lacks a savings or investment component. Unlike other types of life insurance, premiums cover only the cost of insurance and administrative expenses. This design means that term life policies do not build any cash value over time.

Policyholders cannot borrow against term life insurance due to the absence of cash value. Without an accumulated fund, there is no collateral for the insurer to lend against.

Life Insurance Policies with Cash Value

Certain types of life insurance policies are designed to accumulate cash value over time. These include whole life insurance, universal life insurance, and variable universal life insurance. A portion of the premiums paid into these policies is allocated to a cash value component, which grows on a tax-deferred basis.

For whole life policies, the cash value grows at a guaranteed rate, providing predictable accumulation. Universal life policies offer more flexibility, with cash value growth often linked to an interest rate declared by the insurer, which can fluctuate. Variable universal life policies link cash value growth to investment subaccounts, exposing it to market fluctuations.

This cash value becomes an accessible financial resource. This fund, built through premium payments and investment growth, enables policyholders to borrow directly from their policy. The cash value acts as collateral for the loan.

How Policy Loans Operate

A policy loan is an advance of funds from the insurance company, not a direct withdrawal from the policy’s cash value. The loan is secured by the policy’s cash value, which remains intact and continues to grow, potentially earning interest or dividends, while the loan is outstanding. This structure ensures the policy remains active, assuming sufficient cash value exists.

Interest is charged on the outstanding loan balance, with rates typically variable (4-8% annually) or fixed, depending on the contract. This interest accrues over time, increasing the total amount owed on the loan.

Repayment terms for policy loans are flexible, with no mandatory schedule. Policyholders can repay the loan principal and interest, or allow interest to capitalize, adding to the outstanding balance. However, any outstanding loan balance, including accrued interest, will reduce the death benefit paid to beneficiaries upon the insured’s passing.

A potential risk of policy loans is the possibility of policy lapse. If the outstanding loan amount, including accrued interest, grows to exceed the policy’s cash value, the policy can terminate. When a policy lapses with an outstanding loan, the loan amount that exceeds the premiums paid into the policy may become taxable income to the policyholder in the year of the lapse, potentially leading to a tax liability.

Policy loans are generally not considered taxable income as long as the policy remains in force. This tax-favored treatment allows policyholders to access funds without immediate income tax obligations, unlike other loans or withdrawals. Borrowing against cash value provides liquidity without impacting credit scores or requiring external loan applications.