Can You Take a Loan Against Life Insurance?
Unlock the potential of your life insurance policy. Understand the unique process of borrowing against its value and the critical factors to consider.
Life insurance can serve as more than just a financial safety net for beneficiaries after a policyholder’s passing. Certain types of policies offer a feature allowing individuals to borrow against the policy’s accumulated value while they are still living. This option provides a flexible way to access funds for various needs. Understanding this financial tool is important for policyholders.
Policies that Allow Loans
Life insurance policies fall into two main categories: term life and permanent life. Only permanent life insurance policies, such as whole life, universal life, and variable universal life, accumulate cash value. This cash value is a prerequisite for taking a loan. A portion of the premiums paid into these policies is allocated to this cash value component, which grows over time on a tax-deferred basis.
Term life insurance, in contrast, provides coverage for a specific period, typically 10 to 30 years, and does not build any cash value. It usually takes several years for a permanent policy to build enough cash value to make a meaningful loan amount available.
How Life Insurance Loans Function
A life insurance loan is distinct from a conventional bank loan because the policyholder borrows from the cash value accumulated within their own policy. The policy’s cash value acts as collateral for the loan. Unlike traditional loans, there is no credit check, income verification, or formal approval process involved, making access to funds straightforward.
Interest accrues on the outstanding loan balance, similar to other types of loans. If not paid, it is added to the loan principal, increasing the total amount owed. The cash value supporting the loan often continues to earn interest or dividends, which can partially offset the loan interest. Policyholders have flexibility in repaying the loan, with no fixed repayment schedule or penalties for non-adherence.
The funds disbursed from a policy loan do not come directly out of the cash value itself. The insurance company lends the money, using the cash value as security. This allows the cash value to continue growing within the policy, even with an outstanding loan, though growth may be impacted by the loan’s terms. The amount available for a loan is typically a percentage of the cash value, often up to 90%. This provides a flexible and often lower-cost source of funds compared to personal loans or credit cards.
Key Considerations for Policyholders
Policyholders should understand specific implications of taking a loan against a life insurance policy. If the loan, including any accrued interest, is not fully repaid before the policyholder’s death, the outstanding balance will be deducted directly from the death benefit paid to beneficiaries. This reduction can significantly impact the financial security intended for loved ones.
While repayment offers flexibility, with no mandatory schedule, the loan continues to accumulate interest. If interest is not paid, it capitalizes, increasing the loan balance. A risk arises if the outstanding loan balance, along with accrued interest, grows to exceed the policy’s cash value. In such a scenario, the policy can lapse, leading to a loss of coverage.
A policy lapse with an outstanding loan can also trigger adverse tax consequences. The Internal Revenue Service (IRS) may treat the unpaid loan amount, to the extent it exceeds the premiums paid into the policy, as taxable income. This can result in an unexpected tax bill, particularly if the policy had significant gains. Careful monitoring of the loan balance and the policy’s cash value is important to avoid unintended financial and tax liabilities.
Accessing a Policy Loan
Initiating a life insurance policy loan is a straightforward process once sufficient cash value has accumulated. Policyholders typically begin by contacting their insurance company or financial agent to confirm the available loan amount. Insurers usually allow borrowing up to a certain percentage, often around 90%, of the policy’s cash value. This inquiry also helps determine if any specific forms or procedures are required.
The application process for a policy loan does not involve credit checks or extensive underwriting. Policyholders will usually fill out a simple loan request form, which may be available online or over the phone. Required information typically includes the policy number and the desired loan amount.
Once the request is submitted, the funds are usually disbursed quickly. Most insurance companies can process the loan and send the money within a few business days, often via direct deposit or check. The timeframe for receiving funds can range from three to ten business days, depending on the insurer’s processing times.