Can You Borrow From Whole Life Insurance?

Whole life insurance policies offer a unique financial feature beyond a death benefit: the ability to accumulate cash value that policyholders can access during their lifetime. This accumulated value can serve as a source of funds, often through a policy loan.

Understanding Whole Life Cash Value

Whole life insurance policies include a savings component known as cash value, which grows over time. A portion of each premium payment is allocated to this cash value account. This value accumulates on a tax-deferred basis.

The cash value typically grows at a guaranteed rate of interest, providing a predictable accumulation. For participating policies, policyholders may also receive dividends, which are a share of the insurer’s profits and can further enhance cash value growth if reinvested. This accumulated cash value serves as the collateral for a policy loan.

Initiating a Policy Loan

Accessing funds from a whole life insurance policy begins once sufficient cash value has accumulated. This usually takes several years. Policyholders can borrow up to 90% to 95% of their policy’s cash surrender value. The specific percentage can vary by insurer and policy terms.

To initiate a loan, policyholders contact their insurance provider directly. This can often be done through phone, email, or an online portal. Required information usually includes the policy number and the desired loan amount. There is generally no credit check or lengthy approval process involved, as the loan is secured by the policy’s own cash value.

Once the necessary paperwork, such as a loan agreement, is completed and submitted accurately, the loan funds are typically disbursed. Policyholders can expect to receive the funds within a few days to a couple of weeks. Disbursement methods often include direct deposit or a check.

Financial Aspects of Policy Loans

Policy loans from whole life insurance policies function differently from traditional bank loans. While there is interest charged on the borrowed amount, the interest rates are often competitive, commonly ranging between 5% and 8%. These rates can be fixed or variable, as outlined in the policy terms. Interest on the loan accrues over time and, if not paid, will be added to the outstanding loan balance, increasing the total amount owed.

A significant advantage of whole life policy loans is their flexible repayment terms. Policyholders are generally not subject to a fixed repayment schedule and can repay the loan at their discretion. Some may choose to make regular payments, while others may opt to pay only the interest, or even make no payments at all, allowing the loan balance to be deducted from the death benefit later.

An outstanding loan impacts the policy’s financial components. While the underlying cash value continues to grow, the loan balance reduces the net cash value available for withdrawals or surrender. Importantly, if the loan is not repaid, the outstanding balance, including any accrued interest, will be deducted from the death benefit paid to beneficiaries upon the insured’s death. A policy can also lapse if the outstanding loan balance plus accrued interest exceeds the policy’s cash value, potentially leading to a taxable event.

Tax Implications of Policy Loans

Policy loans from whole life insurance policies are generally not considered taxable income, provided the policy remains in force. The Internal Revenue Service (IRS) typically views these loans as an advance against the policy’s cash value rather than a distribution of income. This tax-free access to funds is a notable benefit for policyholders.

However, there are specific scenarios where a policy loan can become taxable. If the policy lapses or is surrendered with an outstanding loan, the loan amount, to the extent of any gain in the policy, can become taxable income. This is because the policy’s gain, which has grown tax-deferred, becomes realized upon lapse or surrender.

A policy may also be classified as a Modified Endowment Contract (MEC) under Internal Revenue Code Section 7702A if it fails a “7-pay test,” meaning premiums paid exceed a certain limit within the first seven years.

Loans from a MEC are treated less favorably for tax purposes; they are taxable to the extent of any gain in the policy, and distributions, including loans, may be subject to a 10% penalty if taken before age 59½. It is also important to note that interest paid on policy loans is generally not tax-deductible for personal policies.