Can You Borrow Against Life Insurance Through Work?
Uncover whether your employer-offered life insurance builds cash value for loans and learn crucial financial implications before borrowing.
Navigating financial decisions can often feel complex, especially when they involve benefits received through employment. Many individuals ask: is it possible to borrow against a life insurance policy obtained through work? Understanding how different life insurance policies accumulate value is essential. This article will clarify the types of life insurance typically offered by employers, explain policy loans, and when borrowing may be an option.
Understanding Life Insurance Through Work
Life insurance offered through an employer falls into two categories. The most prevalent type is group term life insurance, often provided at no cost or low cost to employees. This coverage offers a death benefit for a specific period, typically while employed, but it does not accumulate cash value. Therefore, group term life insurance cannot be borrowed against.
Employers also offer voluntary or supplemental life insurance, which employees can purchase through payroll deductions. These policies, while facilitated by the employer, are typically individual policies that can be either term or permanent. If an employee opts for a permanent life insurance policy, such as whole life or universal life, through this voluntary offering, that policy may build cash value over time. While the employer may negotiate group rates for these voluntary plans, the employee typically owns the policy, unlike group term insurance where the employer is the policyholder.
Cash Value and Policy Loans
Permanent life insurance policies, including whole life and universal life, accumulate cash value over time. This cash value grows as premiums are paid and the policy earns interest or dividends, offering a living benefit alongside the death benefit. The rate at which cash value grows depends on the policy type and its terms, often taking several years to accrue sufficient value for a loan.
A policy loan is an advance from the insurance company, using the policy’s cash value as collateral. It is not a withdrawal of the cash value itself, allowing the remaining cash value to continue growing. Interest accrues on the borrowed amount, like any other loan, with typical rates ranging from 5% to 8%. Policy loans offer flexibility, as they do not require credit checks or rigid repayment schedules.
When Borrowing Against Work-Provided Life Insurance is Possible
Borrowing against life insurance obtained through work depends on the specific policy an employee possesses. Group term life insurance, the most common employer-provided coverage, does not accumulate cash value and therefore cannot be used to secure a loan.
Conversely, if the “life insurance through work” refers to a voluntary or supplemental permanent life insurance policy, such as whole life or universal life, purchased and owned by the employee, then borrowing may be an option. These individual policies, even if facilitated by the employer through payroll deduction, are structured to build cash value over time. Borrowing stems from the policy’s intrinsic cash value, not from the employer directly providing a loan. To determine eligibility, individuals should review their policy documents or contact their employer’s human resources department or benefits administrator to confirm the type of life insurance they have and whether it includes a cash value component.
Key Considerations Before Borrowing
If your permanent life insurance policy allows for loans, understanding the implications is important. Any outstanding loan balance, along with accrued interest, will directly reduce the death benefit paid to beneficiaries. This means beneficiaries will receive a reduced payout if the insured passes away with an unpaid loan.
Interest on the policy loan accrues over time, and if unpaid, it adds to the principal loan amount. This can diminish the policy’s cash value. If the loan balance, including accumulated interest, exceeds the policy’s cash value, the policy may lapse.
A policy lapse with an outstanding loan can trigger a taxable event. The loan amount exceeding premiums paid may be considered taxable income by the IRS, leading to an unexpected tax liability. While policy loans offer flexible repayment options, establishing a repayment plan is advisable to mitigate these risks. Consulting with a financial advisor or the insurance company directly can provide clarity on policy terms and help in making an informed decision.