Can You Take a Loan Against Your Life Insurance?

A life insurance policy loan enables policyholders to borrow money using their policy’s accumulated cash value as security. This financial option provides access to funds without needing to apply for traditional bank loans. Not all life insurance policies build cash value, so only specific types qualify for this borrowing privilege.

Understanding Cash Value Life Insurance

Cash value refers to a component within certain types of permanent life insurance policies that grows over time and can be accessed by the policyholder. This distinct feature is found in policies such as whole life, universal life, and variable universal life insurance. As premiums are paid into these policies, a portion contributes to the death benefit, while another portion is allocated to the policy’s cash value, which accumulates on a tax-deferred basis.

The accumulation of cash value occurs through a combination of premium payments and interest or dividend crediting. For instance, whole life policies typically offer a guaranteed interest rate, while universal life policies may provide a variable interest rate or be linked to market performance. In contrast, term life insurance policies are designed purely for death benefit protection over a specific period and do not build any cash value.

How Life Insurance Loans Function

A life insurance policy loan is not a withdrawal from the policy’s cash value but rather a loan issued by the insurance company, using the cash value as collateral. This distinction is important because the underlying cash value continues to grow and earn interest or dividends, even while a loan is outstanding. The policy remains in force as long as premiums are paid and the outstanding loan balance, including accrued interest, does not exceed the available cash value.

Interest accrues on the policy loan, typically calculated as simple interest rather than the compounded daily interest often seen with other types of loans. Policyholders usually have significant flexibility regarding repayment schedules; there is no mandatory monthly payment requirement. However, interest continues to accumulate on the outstanding loan balance, which can increase the total amount owed over time. If the loan, along with its accrued interest, is not repaid during the insured’s lifetime, the outstanding balance will be directly deducted from the death benefit paid to beneficiaries upon the insured’s passing.

Key Aspects of Policy Loans

A key implication of a life insurance policy loan is its effect on the death benefit. Any outstanding loan balance, along with the accrued interest, will directly reduce the amount of the death benefit paid to the beneficiaries. For instance, if a policy has a $500,000 death benefit and a $50,000 outstanding loan plus $5,000 in accrued interest, the beneficiaries would receive $445,000.

The potential for policy lapse is a key concern. If the outstanding loan amount, combined with its accumulating interest, grows to exceed the policy’s cash value, the policy could terminate. Should a policy lapse with an outstanding loan, the loan amount, up to the extent of any gain in the policy, may become taxable income to the policyholder. For instance, if the policy’s cash value gain was $30,000 and the outstanding loan was $40,000 when it lapsed, $30,000 could be considered taxable income.

Policy loans are generally not considered taxable income when the funds are received, as long as the policy remains active and in force. However, if the policy is surrendered or lapses with an outstanding loan, the loan amount exceeding premiums paid may be subject to income tax. Interest continues to accrue on the loan balance, and while there is no strict repayment schedule, accumulating interest can diminish the available cash value and potentially lead to policy lapse. The full cash value continues to earn interest or dividends, but the net cash value available for future access or surrender is reduced by the loan amount.

Requesting a Policy Loan

Obtaining a policy loan is initiated by contacting the life insurance company. Policyholders need to complete a loan request form provided by the insurer. This form requires basic information such as the policy number, the desired loan amount, and the policyholder’s signature for authorization.

After the request is submitted, the insurance company will review the policy’s cash value to confirm the available loan amount. Funds are often disbursed directly to the policyholder, typically through a check or direct deposit, within a period ranging from a few business days to approximately two weeks. The speed of disbursement can depend on the insurer’s processing times and the method of fund delivery selected.