Can You Borrow Against Voluntary Life Insurance?

Voluntary life insurance is an optional benefit often offered by employers, allowing employees to purchase additional coverage beyond any basic employer-provided plans. Employees typically pay premiums for these policies, often through payroll deductions. Borrowing against a voluntary life insurance policy depends entirely on its type; it’s only an option if the policy accumulates cash value.

Identifying Borrowable Policies

Life insurance policies generally fall into two main categories: term life insurance and permanent life insurance. Term life insurance provides coverage for a specific period and typically does not build cash value. Therefore, voluntary group term life insurance cannot be borrowed against.

In contrast, permanent life insurance policies, such as whole life or universal life, provide coverage for an individual’s entire life and include a cash value component. A portion of each premium payment contributes to this cash value, which grows over time on a tax-deferred basis. This accumulated cash value is the asset against which a policy loan can be taken.

If your voluntary policy is a permanent type, it will accumulate cash value over time, making it eligible for a loan. It is important to confirm your policy type, as only policies with a cash value feature allow for borrowing.

The Policy Loan Process

When you borrow against a cash value life insurance policy, you are taking a loan from the insurer, using your policy’s accumulated cash value as collateral. This collateralization means that policy loans typically do not require a credit check or a lengthy approval process, as the loan is backed by your own policy’s value.

The amount you can borrow is usually a percentage of your policy’s current cash value, commonly up to 90%. For example, if your policy has $10,000 in cash value, you might be able to borrow up to $9,000. It generally takes a few years for a policy to build sufficient cash value to make a substantial loan feasible.

Policy loans do accrue interest, with typical interest rates ranging from 5% to 8%. This interest can be fixed or variable, depending on the policy’s terms. While there are no strict repayment schedules for these loans, interest continues to accumulate on the outstanding balance.

Managing Your Policy Loan

Managing a life insurance policy loan involves understanding its impact on your policy and the flexible repayment options available. Policy loans generally offer flexible repayment terms, meaning you are not tied to a strict schedule for repayment. You can choose to make regular payments, pay only the interest, or even make no repayments at all. However, it is important to note that interest will continue to accrue on the outstanding loan balance.

An outstanding loan, including any accrued interest, will directly reduce the death benefit paid to your beneficiaries. If you pass away with an unpaid loan, the insurer will deduct the loan amount from the death benefit before distributing the remainder to your beneficiaries. This reduction can significantly impact the financial support intended for your loved ones.

A significant risk associated with policy loans is the potential for the policy to lapse. If the outstanding loan amount, including accumulated interest, grows to exceed the policy’s cash value, the policy can terminate. Should the policy lapse due to an unpaid loan, it can trigger adverse tax implications. The amount of the loan that exceeds the premiums paid into the policy may become taxable income, leading to an unexpected tax liability. This is because the IRS may view the outstanding loan as a constructive distribution, making the gain taxable, even if no cash was directly received by the policyholder at the time of lapse.