Can You Borrow From Your Life Insurance?

Life insurance serves primarily as a financial safety net, providing a death benefit to beneficiaries upon the policyholder’s passing. Beyond this fundamental protection, certain types of life insurance policies offer an additional feature: the accumulation of cash value. This cash value component can grow over time, creating a valuable asset accessible to the policyholder during their lifetime. Understanding how this feature works allows policyholders to consider their insurance not just for future protection but also as a potential source of funds.

Life Insurance Policies That Allow Borrowing

Not all life insurance policies are structured to allow borrowing; this ability is tied directly to whether a policy builds cash value. Permanent life insurance policies accumulate cash value, which can then be leveraged by the policyholder. These include Whole Life, Universal Life, Variable Universal Life, and Indexed Universal Life insurance policies. A portion of each premium payment made on these policies is allocated to the cash value component, which then grows on a tax-deferred basis. This growth is often guaranteed or tied to market performance, depending on the specific policy type.

Whole Life insurance, for example, offers a fixed premium and a guaranteed cash value growth rate, providing predictability for policyholders. Universal Life insurance provides more flexibility, allowing adjustments to premiums and death benefits, with cash value growth influenced by an insurer’s declared interest rates. Variable Universal Life and Indexed Universal Life policies offer additional investment options, where the cash value can fluctuate based on the performance of underlying investments or market indexes.

Conversely, Term Life insurance policies do not build cash value. These policies are designed to provide coverage for a specific period, such as 10, 20, or 30 years, and offer only a death benefit if the insured passes away within that term. Therefore, the ability to borrow from a life insurance policy is exclusively available to those holding permanent life insurance contracts that feature a cash accumulation component.

How Life Insurance Loans Function

When a policyholder takes a loan from their life insurance, they are not actually withdrawing their own money from the policy’s cash value. Instead, the insurance company lends money to the policyholder, using the policy’s cash value as collateral for the loan. This arrangement means the cash value remains within the policy, continuing to earn interest or dividends as specified by the policy’s terms, even while the loan is outstanding. The loan is essentially a debt against the policy, with the cash value securing the insurer’s risk.

Interest accrues on the outstanding loan balance, and the interest rates typically range from approximately 5% to 8%, depending on the insurer and whether the rate is fixed or variable. While there is no strict repayment schedule for a policy loan, and repayment is generally flexible, interest payments are important. If interest is not paid, it can be added to the outstanding loan balance, causing the loan to grow. An increasing loan balance, especially if interest continues to compound, can eventually reduce the policy’s cash value and potentially lead to the policy lapsing.

A significant consequence of an outstanding policy loan is its impact on the death benefit. If the policyholder passes away with an unpaid loan, the outstanding loan balance, including any accrued interest, will be deducted from the death benefit paid to beneficiaries. This means the beneficiaries will receive a reduced payout. Furthermore, if a policy lapses with an outstanding loan, the loan amount that exceeds the premiums paid into the policy can become taxable income. The IRS considers this a taxable event, and the policyholder could receive a Form 1099-R, potentially incurring a significant tax liability, especially if the policy had substantial gains.

Steps to Obtain a Policy Loan

Accessing a loan from a life insurance policy involves a straightforward process, primarily because the policy’s cash value serves as collateral, eliminating the need for credit checks or extensive approval procedures. The initial step for a policyholder is to confirm their eligibility and the available loan amount. Policyholders should then ascertain their current cash value and the maximum amount available for a loan, which is typically up to 90% of the policy’s cash value. This information is often accessible through the insurance company’s online portal or by contacting their customer service department.

Once the desired loan amount is determined, the policyholder can initiate the request by contacting their insurance provider. This can often be done by phone, through the insurer’s online portal, or by submitting a specific loan request form provided by the company. While the policy itself acts as collateral, some insurers may require a signed loan agreement or additional documentation. There are generally no restrictions on how the loan proceeds can be used, offering flexibility to the policyholder.

After submitting the request, the processing time for a life insurance policy loan is typically relatively quick. Funds are often disbursed within approximately one week, though it can range from five to ten business days. Disbursement methods can vary by insurer, with options including electronic funds transfer (EFT) directly to a bank account or a physical check mailed to the policyholder. If an EFT is preferred, the insurer may require banking information, such as a voided check or a signed EFT form.