Can You Take a Loan From Term Life Insurance?

Life insurance provides security for dependents after an individual’s passing. Many consider how life insurance might assist with immediate monetary needs during their lifetime. While its primary purpose is a death benefit, features and fund accessibility differ significantly across policy types. Understanding these distinctions is important for those exploring policy use for financial purposes.

Understanding Term Life Insurance

Term life insurance offers coverage for a specific period (e.g., 10, 20, or 30 years) and is for protection. It provides a death benefit to beneficiaries if the insured passes away within the defined term. A key characteristic is its lack of a cash value component. Because term policies do not accumulate cash value, they are more affordable than other life insurance options.

With no savings or investment element, policyholders cannot take out loans against it. Premiums solely cover the death benefit cost for the specified period. Thus, if an individual seeks accessible funds from a life insurance policy, a term life policy would not fulfill that need. This insurance focuses solely on providing coverage for a set duration without building living benefits.

Understanding Permanent Life Insurance

Permanent life insurance provides coverage for an individual’s entire lifetime, assuming premiums are paid. These policies include a cash value feature, which accumulates over time. Common types that build cash value include whole life, universal life, variable universal life, and indexed universal life. A portion of each premium contributes to this cash value, which grows on a tax-deferred basis.

Cash value can grow through various mechanisms, such as a guaranteed fixed interest rate for whole life policies or a rate dependent on market performance for universal life policies. This accumulation creates a living benefit accessible during the policyholder’s lifetime. This accumulated cash value serves as the foundation for policy loans, distinguishing permanent life insurance from term policies regarding accessible funds. The growth of this cash value can be a significant financial asset over the policy’s duration.

How Policy Loans Operate

Policy loans allow policyholders to borrow money using their accumulated cash value as collateral. The insurance company lends funds against the policy’s cash value, without requiring an application process, credit check, or income verification. This makes the loan accessible without impacting one’s credit report. Insurers permit borrowing up to a certain percentage of the cash value, often around 90%.

Interest is charged on the loan, with rates ranging from 5% to 8%, which can be lower than personal loans or credit cards. While there is no strict repayment schedule, interest accrues on the outstanding loan balance. The cash value continues to earn interest or dividends, even with an outstanding loan, though net growth may be affected by the loan interest. If the loan and accrued interest are not repaid, the outstanding amount is deducted from the death benefit paid to beneficiaries.

Implications of Taking a Policy Loan

Taking a loan from a permanent life insurance policy has several implications. The most direct impact is on the death benefit: any outstanding loan balance, including accrued interest, reduces the amount paid to beneficiaries upon the insured’s death. This means beneficiaries receive less than the policy’s stated death benefit. Policyholders can repay the loan over time, but if not repaid, the death benefit reduction becomes permanent.

Unpaid loans and accumulating interest can pose a risk of policy lapse. If the outstanding loan balance, including interest, exceeds the policy’s cash value, the policy could terminate. A policy lapse due to an outstanding loan can lead to tax implications, especially if the loan amount exceeds the total premiums paid into the policy. The cash value used for a loan is not available for other purposes, representing an opportunity cost for the policyholder. Monitoring the loan balance relative to the cash value is important to avoid unintended consequences and ensure the policy remains in force.