Can You Borrow Against Life Insurance?

Borrowing against a life insurance policy can provide access to funds when needed. This option is associated with certain types of life insurance policies that build a cash value component over time. Understanding this process, the policies involved, and potential implications is important for policyholders considering this approach.

Policies with Cash Value

Life insurance policies designed to last for an individual’s entire life, known as permanent life insurance, often include a savings feature called cash value. This cash value grows over time. Common types of permanent life insurance that accumulate cash value include whole life, universal life, variable universal life, and indexed universal life policies.

A portion of each premium payment is allocated to this cash value account, separate from the amount covering the death benefit and policy fees. This cash value grows on a tax-deferred basis, meaning earnings are not taxed until withdrawn or the policy is surrendered. The rate at which cash value accumulates can vary; whole life policies typically offer a guaranteed growth rate, while universal life policies may have a variable rate tied to market conditions or a specified index. Term life insurance policies, which provide coverage for a set period, do not build cash value and therefore cannot be borrowed against.

Understanding a Life Insurance Loan

A loan taken from a life insurance policy is distinct from a traditional bank loan or a withdrawal from a savings account. When a policyholder borrows against their life insurance, the policy’s accumulated cash value serves as collateral. The cash value remains within the policy, continuing to grow and earn interest or investment gains even while a loan is outstanding. This means the policy’s underlying assets are not liquidated to provide the loan funds.

Interest accrues on the outstanding loan balance, with typical rates ranging from approximately 5% to 8%, which can be fixed or variable depending on policy terms. Unlike conventional loans, there is usually no fixed repayment schedule for a life insurance policy loan. Policyholders have the flexibility to repay the loan at their own pace, or even not repay it at all, though interest continues to accumulate. An outstanding loan balance, including accrued interest, will reduce the death benefit paid to beneficiaries upon the insured’s passing.

Accessing Your Policy’s Cash Value

Obtaining a loan against a life insurance policy with cash value involves a straightforward process. Policyholders begin by contacting their insurance provider directly, through customer service, their agent, or an online portal. The insurer will confirm the available cash value and the maximum loan amount, which is often up to 90% of the policy’s cash value.

There is typically no credit check or approval process involved, as the loan is secured by the policy’s own value. After the loan request is submitted, funds are usually disbursed within a few business days, often via check or direct deposit. While there is no mandatory repayment schedule, policyholders can choose to repay the loan in a lump sum, through periodic payments, or by simply paying the annual interest. Repayment flexibility allows for varied payment amounts and intervals, and there are no penalties for early repayment or for skipping payments. It usually takes several years, commonly between 2 to 10 years, for a policy’s cash value to grow sufficiently to make a substantial loan possible.

Implications of Unpaid Loans

Failing to repay a life insurance policy loan carries consequences for both the policy and its beneficiaries. If the outstanding loan balance, along with any accrued interest, grows to exceed the policy’s cash value, the policy can lapse. A policy lapse means coverage terminates, and the death benefit is no longer in force.

A policy lapse due to an unpaid loan can also trigger a taxable event. The Internal Revenue Service (IRS) may treat the outstanding loan amount, to the extent it exceeds the premiums paid into the policy (the policyholder’s “basis”), as taxable ordinary income. This can result in an unexpected tax bill, particularly if substantial gains have accumulated within the policy. Any unpaid loan balance and accumulated interest will permanently reduce the death benefit paid to the beneficiaries.