Can I Take Out a Loan on My Term Life Insurance Policy?

Life insurance serves as a financial safeguard, providing a death benefit to beneficiaries upon the policyholder’s passing. A common question involves accessing funds from these policies while living, particularly through loans. The ability to do so depends significantly on the specific type of life insurance policy held, as not all policies are structured to allow for such financial access.

Understanding Life Insurance Cash Value

Life insurance policies broadly fall into two categories: term life and permanent life insurance. Term life insurance provides coverage for a specific duration, such as 10, 20, or 30 years. It is designed purely for death benefit protection and does not accumulate a cash value, meaning there is no savings component from which to borrow. Once the term expires, coverage ceases unless renewed or converted.

Permanent life insurance, encompassing types like whole life, universal life, variable universal life, and indexed universal life, offers lifelong coverage. These policies feature a cash value component, which grows over time on a tax-deferred basis. This cash value is a portion of the premium payments that accumulates, creating a living benefit that the policyholder can access during their lifetime. Policy loans are exclusively available from this accumulated cash value.

Accessing Funds Through Policy Loans

Taking a loan from a permanent life insurance policy means borrowing money from the insurer, with the policy’s cash value serving as collateral. This is not a withdrawal, which permanently reduces the cash value and death benefit, but rather a loan that must be repaid.

The process is often straightforward, typically not requiring a credit check or a lengthy application process, as the loan is secured by the policy’s own value. Most insurers permit borrowing up to 90% of the policy’s accumulated cash value.

Policy loans come with an interest rate, which can be fixed or variable, commonly ranging from 5% to 8%. There is often flexibility in repayment, with no strict repayment schedule, allowing policyholders to pay back the principal and interest at their discretion, or even just the interest. However, any outstanding loan balance, including accrued interest, will be deducted from the death benefit paid to beneficiaries if the policyholder passes away before repayment.

An outstanding loan carries the risk of policy lapse. If the loan amount, combined with accumulated interest, grows to exceed the policy’s cash value, the policy can terminate. A policy lapse due to an outstanding loan can also trigger a taxable event, where any gains in the policy’s cash value exceeding the premiums paid become taxable income.

Alternatives for Term Policyholders

Term life insurance policies, by their nature, do not build cash value and therefore do not offer the option of taking out a policy loan. For individuals holding term policies who need access to funds, external financial solutions are necessary. These alternatives might include seeking a personal loan from a bank or credit union, utilizing a home equity loan if they own a home, or drawing upon other personal savings or investment accounts.

Another consideration for term policyholders is the possibility of converting their policy to a permanent life insurance policy. Many term policies offer a conversion option, allowing the policyholder to switch to a permanent policy, often without the need for a new medical examination.

While this conversion would allow the new permanent policy to begin accumulating cash value over time, it is not an immediate solution for accessing funds. Premiums for permanent policies are generally higher than for term policies due to the lifelong coverage and cash value component. This conversion can be a strategic move for long-term financial planning.