Can You Borrow Money From a Life Insurance Policy?

Policyholders can access funds from certain life insurance policies through a loan. This offers a potential financial resource by utilizing the accumulated cash value within the policy. This approach allows policyholders to leverage their insurance coverage beyond its death benefit.

Policies Eligible for Loans

Not all life insurance policies allow for policy loans; eligibility depends on a “cash value” component. Cash value is the savings element within a permanent life insurance policy that grows over time.

Permanent policies like whole life, universal life, and variable universal life insurance build cash value. This cash value grows on a tax-deferred basis and can be accessed through loans or withdrawals. Its growth rate varies, either through guaranteed interest rates (whole life) or market-based investment performance (variable universal life).

Conversely, term life insurance policies do not build cash value. These policies provide coverage for a specific period and only pay a death benefit if the insured dies within that term. Without cash value, term life insurance does not offer the option to borrow money.

Understanding Policy Loan Mechanics

A life insurance policy loan functions as a loan taken against the policy’s cash value, with the policy serving as collateral. Funds typically come from the insurer’s general assets, not directly from the policyholder’s cash value account. This allows the cash value to continue growing within the policy, even while a loan is outstanding.

Interest rates on policy loans can be fixed or variable, outlined in the policy contract or adjusted periodically by the insurer. Interest accrues on the outstanding loan balance. Policyholders are responsible for paying this interest. While there is no strict repayment schedule, consistent interest payments are necessary to maintain the policy.

The loan is generally not considered taxable income because it is a debt, not a distribution of earnings, as long as the policy remains in force. The policy’s cash value continues to earn interest or grow, which can sometimes be offset by the interest charged on the loan.

Effects of an Outstanding Loan

An outstanding loan on a life insurance policy directly impacts the benefits available. The death benefit payable to beneficiaries is reduced by the outstanding loan amount, plus any accrued and unpaid interest, upon the insured’s passing.

An outstanding loan also decreases the policy’s cash surrender value. If the policyholder surrenders the policy, the loan balance and any accrued interest are deducted from the accumulated cash value.

A risk with an outstanding loan is the potential for policy lapse. If the loan balance, including accumulated interest, exceeds the policy’s cash value, the policy may terminate. Should a policy lapse with an outstanding loan, the loan amount exceeding the basis (premiums paid) could become taxable income. Unpaid interest is typically added to the loan principal.

Requesting a Policy Loan

Initiating a policy loan requires the policyholder to provide specific information to the insurance carrier. This usually includes the policy number, desired loan amount, and current contact details. Some insurers may also require identity verification.

Policyholders can initiate a loan request through various channels provided by their insurer. Common methods include contacting customer service, utilizing an online policyholder portal, or submitting a specific loan request form.

Once submitted, the insurer processes the application, and funds are typically disbursed within a few business days. Upon approval, funds are usually disbursed through direct deposit or physical check. The insurer will also provide a loan agreement or statement detailing the loan terms, including the interest rate and repayment options.