Can You Borrow From Term Life Insurance?

Life insurance is a contract where an insurer pays a sum of money to designated beneficiaries upon the insured person’s death. Policyholders often wonder if they can access funds from these policies during their lifetime.

Understanding Term Life Insurance

Term life insurance provides coverage for a specific period, known as the “term,” which can range from one to thirty years. It offers a death benefit if the insured passes away within this defined term. Its purpose is pure protection, ensuring financial security for beneficiaries during periods like raising young dependents or paying off a mortgage.

Term life insurance does not accumulate cash value. Premiums paid for term policies are allocated solely to cover the cost of insurance for the specified term. This lack of cash value contributes to term life insurance having lower premiums compared to other types of life insurance.

Once the policy’s term expires, the coverage ends, unless renewed or converted. If the insured outlives the term, there is no payout from the policy, and the premiums paid are nonrefundable.

The Concept of Life Insurance Loans

Policy loans from life insurance are possible only when a policy has accumulated a “cash value.” Cash value is a savings component that grows over time within certain types of life insurance policies, such as whole life or universal life. A portion of the premiums paid into these policies is allocated to this cash value, which can grow on a tax-deferred basis.

Policyholders can borrow against this accumulated cash value, using it as collateral for the loan. The loan is not issued by a traditional lender like a bank but directly by the insurance company. This process bypasses the need for credit checks or a formal approval process, relying instead on the policy’s established cash value.

Interest is charged on these policy loans, with rates ranging from 5% to 8%, which can be fixed or variable. Policyholders have flexibility in repayment, including making scheduled payments or allowing the loan balance and accrued interest to reduce the death benefit. Any outstanding loan balance, including unpaid interest, will reduce the amount paid to beneficiaries upon the insured’s death.

Why Term Life Does Not Offer Loans

You cannot borrow from a term life insurance policy. This is because term life insurance policies do not build a cash value component. Cash value is the necessary basis against which policy loans are made.

Term life insurance is structured purely as a protection product, providing a death benefit for a specific period. Since there is no cash value to serve as collateral, there is no mechanism for the policyholder to take a loan against a term life policy.

Accessing Funds from Permanent Life Insurance

When sufficient cash value has accumulated within a permanent life insurance policy, such as whole life or universal life, a policyholder can request a loan from the insurer. The process involves contacting the insurance company and completing a loan request form. The insurer then disburses the funds within a few days, without requiring a credit check.

The amount available for a loan is limited, with insurers allowing policyholders to borrow up to 90% of the policy’s accumulated cash value. While the loan accrues interest, which varies by insurer and policy type, repayment schedules are flexible. Policyholders can choose to repay the loan over time, or they can allow the outstanding loan balance and any accrued interest to be deducted from the death benefit when the policy matures or the insured passes away.

Policy loans are not considered taxable income as long as the policy remains in force and the loan amount does not exceed the premiums paid into the policy. However, if the policy lapses or is surrendered with an outstanding loan, any gains exceeding the premiums paid may become taxable. The policy’s cash value continues to grow even with an outstanding loan, as the loan is made by the insurer using the policy as collateral, rather than directly from the cash value.