Can I Borrow Money From My Term Life Insurance Policy?

When unexpected financial needs arise, many individuals wonder if they can borrow money directly from their life insurance policy. However, the ability to access funds through a loan depends significantly on the specific type of policy held. Life insurance policies are structured differently, and these differences dictate whether a loan feature is available.

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 passes away within that defined term.

Term life insurance policies do not accumulate cash value. This means there is no savings component or investment fund built within the policy that the policyholder can access while alive. Since a policy loan is fundamentally borrowing against the accumulated cash value, term life insurance policies do not allow policyholders to borrow money directly from them. The absence of this cash value component is why term policies are generally less expensive than permanent life insurance options.

Types of Life Insurance That Allow Loans

In contrast to term life insurance, permanent life insurance policies are designed to build cash value over time, making them a potential source for policy loans. These policies, which include whole life, universal life, and variable universal life insurance, offer lifelong coverage as long as premiums are paid. A portion of each premium payment contributes to this cash value component, which then grows on a tax-deferred basis. This accumulated cash value serves as the collateral for any loans taken against the policy. It typically takes a few years, often between two to five years, for sufficient cash value to accumulate before a policy loan becomes a viable option.

Mechanics of a Life Insurance Policy Loan

When a policyholder takes a loan from a permanent life insurance policy, they are borrowing against the policy’s cash value, not from the insurer’s general funds. The loan amount is typically limited to a percentage of the accumulated cash value, often up to 90% or 95%. Unlike conventional loans, policy loans do not usually involve a credit check or a strict repayment schedule. Interest accrues on the outstanding loan balance, with rates typically ranging from 5% to 8%, and these rates can be fixed or variable depending on the policy.

While there is no mandatory repayment schedule, interest must be paid. If left unpaid, interest can be added to the loan principal, causing the loan balance to grow. An outstanding loan, including accrued interest, reduces the death benefit paid to beneficiaries if the insured passes away before the loan is fully repaid.

If the loan balance, along with accrued interest, grows to exceed the policy’s cash value, the policy can lapse. A policy lapse with an outstanding loan may trigger a taxable event. The amount of the loan exceeding the policy’s cost basis (premiums paid) can be considered taxable income. The loan proceeds themselves are not taxed as income unless the policy lapses or is surrendered.

Alternatives for Accessing Funds

Since term life insurance does not offer a loan feature, individuals needing to access funds can explore other financial avenues.

Personal Loans

Personal loans from banks or credit unions are a common option, with interest rates ranging from 6.5% to 36% APR, depending on creditworthiness and lender.

Home Equity Loans/HELOCs

Homeowners can consider a home equity loan or a home equity line of credit (HELOC), which leverage the equity built in a home. Home equity loan rates average 8.25%, and HELOC rates average 8.13%.

401(k) Loans

Borrowing from retirement accounts, such as a 401(k), can also provide access to funds. A 401(k) loan allows borrowing up to $50,000 or 50% of the vested account balance, whichever is less, with repayment required within five years. Interest rates on 401(k) loans are the prime rate plus one or two percentage points, and the interest paid goes back into the borrower’s account.

Credit Card Cash Advances

Credit card cash advances are another option, though they come with high interest rates, between 22.99% and 29.99%, and immediate interest accrual plus transaction fees, making them a costly choice.

Consulting a financial advisor can help individuals assess their financial situation and determine the most suitable strategy for accessing funds.