Can You Borrow From a Universal Life Insurance Policy?
Yes, you can borrow from your Universal Life insurance policy. Learn how it works, its effects, and how to repay.
Universal Life (UL) insurance is a type of permanent life insurance providing lifelong coverage. Unlike term life insurance, UL policies feature a cash value component that grows over time. Policyholders can access this cash value during their lifetime. A common method for accessing these funds is through a policy loan, which allows policyholders to tap into the policy’s accumulated value.
Understanding Policy Loans
A Universal Life policy loan is a loan against the policy’s accumulated cash value, not a direct withdrawal. The insurance company acts as the lender, and the policy’s cash value serves as collateral. This arrangement means the policy remains in force, and the cash value continues to grow, although the net accessible cash value is reduced by the loan balance.
Interest accrues on the loan balance, and the interest rate and terms are outlined in the policy contract. While rates vary by insurer and policy, they fall within a range, usually between 6% to 8%, and sometimes lower than traditional loans. Policyholders do not withdraw their own money; they create a debt secured by the policy’s value. This structure allows the policy’s cash value to continue earning interest or investment gains, even with an outstanding loan, although the loaned amount may not participate in these gains.
Insurance companies permit borrowing up to 90% of the policy’s cash value. It takes several years for a UL policy to build sufficient cash value to support a loan, as cash value growth depends on premium payments and policy terms. Since the loan is secured by the policy’s cash value, no credit check or income verification is required.
Impact of a Policy Loan
Taking a loan against a Universal Life policy carries several consequences. An outstanding loan directly reduces the death benefit payable to beneficiaries. If the insured passes away with an unpaid loan, the outstanding loan balance, including any accrued interest, is deducted from the death benefit before it is paid out. This means beneficiaries receive a smaller payout than the policy’s face amount.
A risk associated with policy loans is the policy lapsing. If the loan balance, along with accumulated interest, grows to exceed the policy’s cash value, the policy can terminate. This situation can lead to loss of coverage and tax implications. When a policy lapses with an outstanding loan, the Internal Revenue Service (IRS) may treat the unpaid loan amount, plus any gains in the policy (cash value minus premiums paid), as taxable income. This can result in a tax bill, as these gains are taxed as ordinary income.
While the loan does not remove money from the policy’s cash value, it reduces the net cash value available for future use or surrender. The portion of the cash value used as collateral for the loan is encumbered. This can limit the policyholder’s ability to take additional loans or make withdrawals. The policy’s financial health can be compromised if the loan is not managed carefully, impacting its long-term benefits and stability.
Repaying a Policy Loan
Universal Life policy loans offer flexibility regarding repayment, unlike traditional bank loans. There is no fixed repayment schedule, allowing policyholders to repay the loan partially or in full at any time. Policyholders can make payments at their discretion, whether through a lump sum, regular installments, or by only paying interest. This flexibility means the loan does not appear on credit reports, nor does it affect credit scores.
Repaying the loan has direct positive effects on the policy. As payments are made, the policy’s cash value is replenished. This restoration of the cash value also leads to the restoration of the death benefit to its original amount, ensuring that beneficiaries receive the full intended payout. Responsible repayment helps maintain the policy’s integrity and long-term value.
Conversely, not repaying the loan carries consequences. The outstanding loan balance continues to accrue interest, which can compound over time, further eroding the policy’s cash value. If the loan and its accumulating interest grow too large relative to the cash value, the policy faces an increased risk of lapse. Should the policy lapse due to an unrepaid loan exceeding the cash value, any gains in the policy could become taxable income, resulting in a tax obligation.
Requesting a Policy Loan
Initiating a Universal Life policy loan involves a straightforward process, as the policy’s cash value serves as collateral. The first step involves contacting the insurance provider or a financial advisor to verify the available cash value and maximum loan amount. Most insurers allow borrowing up to 90% of the policy’s cash value, provided enough value has accumulated.
To request the loan, policyholders need to complete a loan application form provided by the insurer. This form requires information such as the policy number, the desired loan amount, and policyholder identification details. Some insurers may also require documentation if the policy has been assigned as collateral to another financial institution or if the owner is a trust or business.
Loan requests can be submitted by contacting the insurer’s customer service, through an online portal if available, or by mailing the completed form. Once the request is submitted, the processing time can vary, but funds are disbursed within a few days to a few weeks. The approved loan amount is disbursed via direct deposit into a bank account or by check. Policyholders should also expect to receive confirmation documents detailing the loan terms, including the interest rate and repayment expectations.