Can You Borrow Money From Life Insurance?

Life insurance policies primarily offer financial protection for beneficiaries after an insured’s passing, but certain types of policies can also serve as a financial resource during the policyholder’s lifetime. This access typically involves leveraging the policy’s accumulated value. Understanding how this process works is important for policyholders considering this option.

Types of Life Insurance Policies That Allow Loans

Life insurance policies are generally categorized into two main types: term life and permanent life. Term life insurance provides coverage for a specific period, such as 10, 20, or 30 years, and does not accumulate any cash value. Consequently, policyholders cannot borrow against a term life insurance policy.

Permanent life insurance policies, however, include a component known as cash value, which grows over time. This cash value is a portion of the premiums paid that accumulates within the policy on a tax-deferred basis. It can be accessed by the policyholder while they are still alive.

Whole life insurance is a type of permanent policy where the cash value grows at a guaranteed rate. Universal life insurance offers more flexibility in premiums and death benefits, with the cash value growth often tied to an interest rate set by the insurer. Variable universal life insurance allows policyholders to invest the cash value in various sub-accounts, such as stocks or bonds, offering potential for higher growth but also increased risk.

The accumulated cash value serves as the basis for borrowing, providing a liquid asset that can be accessed without surrendering the policy.

How a Life Insurance Policy Loan Works

A life insurance policy loan is not a traditional loan from a bank or financial institution. Instead, it is an advance of funds from the insurance company, using the policy’s accumulated cash value as collateral. The policy itself securing the advance. This means that typical credit checks, often required for other loan types, are generally not necessary.

The cash value within the policy generally continues to accrue interest or investment gains even while a loan is outstanding. However, the loan balance itself also accrues interest, which is added to the total amount owed. This interest rate is determined by the insurance company and can vary.

If the loan is not repaid during the policyholder’s lifetime, the outstanding loan balance, including any accrued interest, will be deducted from the death benefit paid to beneficiaries. The policy’s cash surrender value may also be reduced by accessing the funds.

Important Considerations for a Policy Loan

Policy loans offer flexible repayment structures. While this flexibility can be an advantage, interest continues to accrue on the outstanding loan balance. Interest rates for policy loans typically range from approximately 5 percent to 8 percent, depending on whether they are fixed or variable. These rates can be more competitive than those for other personal loans.

Failure to repay the loan can have consequences for the policy. If the outstanding loan balance, including accrued interest, grows to exceed the policy’s cash value, the policy may lapse. A policy lapse means the coverage terminates, and the death benefit is no longer in force. This can also trigger a taxable event for the policyholder.

Policy loans are generally not considered taxable income as long as the policy remains active. However, if the policy lapses or is surrendered with an outstanding loan, the portion of the loan that exceeds the premiums paid into the policy may become taxable income.

Applying for and Receiving a Policy Loan

Initiating a life insurance policy loan typically involves contacting the insurance company that issued the policy. Policyholders will need to request the necessary forms or procedures for obtaining a loan. The insurer will generally require information such as the desired loan amount and verification of policy details.

The amount available for a loan is directly tied to the policy’s accumulated cash value, with many insurers allowing access to up to 90% or 95% of this value. The processing time for a policy loan can vary, but some providers indicate a quick turnaround time for accessing funds. Once approved, the funds can often be received through methods such as direct deposit or a check.

After the loan is issued, the outstanding balance and any accrued interest will be reflected on subsequent policy statements. Insurance companies typically provide regular updates regarding the loan status. Policyholders should monitor the loan balance to prevent it from exceeding the cash value and potentially causing the policy to lapse.