Can You Borrow Money From Whole Life Insurance?

Whole life insurance is a permanent form of life insurance that offers coverage for an individual’s entire life. A defining characteristic is the accumulation of cash value over time, which grows on a tax-deferred basis. This savings component provides a financial resource for policyholders, often accessed through a policy loan.

Understanding Whole Life Policy Loans

A whole life policy loan is a loan issued by the insurance company, with the policy’s cash value serving as collateral. The funds typically come from the insurer’s general assets, not directly from the policyholder’s cash value account. This means the cash value continues to grow, often earning dividends, even while a loan is outstanding.

Policy loans differ from traditional bank loans. No credit checks are required for approval, and the loan does not appear on personal credit reports. Policy loans offer flexible repayment terms, with no fixed schedule for principal repayment. Interest accrues on the outstanding balance, typically ranging from 5% to 8%, which can be fixed or variable.

The interest on a policy loan compounds over time, increasing the total amount owed if left unpaid. This interest impacts the policy by reducing the net cash value and, consequently, the death benefit if the loan is not repaid before the policyholder’s death. Despite an outstanding loan, the policy remains in force as long as premiums are paid and the loan interest is covered, preserving the death benefit and other policy guarantees.

Obtaining a Policy Loan

Before initiating a policy loan request, a policyholder should determine the available loan amount. Insurers allow borrowing up to a certain percentage of the accumulated cash value, commonly around 90%. This amount is reduced by any existing loans or liens. Policyholders also need their policy number to streamline the process.

To initiate a loan, policyholders can contact their insurance company directly through various channels, such as phone, online portal, or by requesting a loan application form. If a form is required, it will ask for the desired loan amount and preferred disbursement method, such as direct deposit or check. Funds can take one day to 15 days to receive, sometimes up to 30 days.

Once the request is submitted, the insurance company processes the application. Because the policy’s cash value acts as collateral, the approval process does not involve extensive underwriting or credit checks. Funds are then disbursed according to the chosen method, providing policyholders with quick access to liquidity.

Managing and Repaying Policy Loans

Managing an outstanding whole life policy loan involves understanding its flexible nature and potential implications. While there are no mandatory principal payments, interest continues to accrue on the loan balance. This flexibility allows policyholders to repay the loan at their own pace, or not at all, as long as the policy remains active.

A consequence of an outstanding loan is the reduction of the policy’s death benefit. The unpaid loan balance, including any accrued interest, is deducted from the death benefit paid to beneficiaries upon death. This means beneficiaries will receive a lower payout than the policy’s face amount if the loan is not fully repaid.

Non-repayment of a policy loan can lead to consequences, including the potential for the policy to lapse. If the total loan balance, including accumulated interest, grows to exceed the policy’s available cash value, the policy can terminate. Insurers notify policyholders before a lapse occurs due to an excessive loan, allowing time to address the issue.

Policyholders have several options for repayment, ranging from making a lump-sum payment to periodic payments of principal and interest, or even just paying the interest annually to prevent the loan from growing. Some policyholders choose to make no payments, allowing the loan to reduce the death benefit. An outstanding loan might affect policy dividends; for participating policies, the portion of cash value used as collateral for the loan may earn reduced or no dividends.

Tax Considerations for Policy Loans

Policy loans from whole life insurance are not considered taxable income as long as the policy remains in force. This is because the loan is viewed as a debt against an asset, rather than a distribution of gains or income. The Internal Revenue Service (IRS) treats these transactions as loans, not withdrawals, for tax purposes.

However, an exception arises if the policy lapses or is surrendered (terminated) while an outstanding loan exists. In such cases, the amount of the loan that exceeds the policy’s cost basis—the total premiums paid into the policy, less any untaxed distributions—can become taxable as ordinary income. This tax liability can be substantial, potentially exceeding the remaining cash value, particularly if significant gains have accumulated.

Interest paid on policy loans is not tax-deductible for individuals. This is because the loan is considered a personal debt, rather than a business expense or an investment loan. While policy loans offer a flexible way to access funds, understanding these tax implications is essential to avoid unforeseen liabilities.