Can You Take a Loan on Your Life Insurance?

A life insurance loan offers a way to access funds using the accumulated value within a policy. Policyholders borrow money directly from their policy’s cash reserves. This operates distinctly from traditional bank loans, providing liquidity without involving external lenders. The process leverages the policy’s inherent value, not requiring an application based on credit scores or outside collateral.

Types of Policies Eligible for Loans

Only specific types of permanent life insurance policies accumulate a cash value component that can be borrowed against. Term life insurance, for instance, does not build cash value and therefore does not offer a loan option.

Whole life insurance is one type that allows loans, as it features guaranteed cash value growth over time. This cash value increases at a fixed rate, often specified in the policy contract, providing predictability for policyholders. The accumulation is tied to the policy’s face amount and the premiums paid.

Universal life insurance also builds cash value, making it eligible for policy loans. This type of policy offers more flexibility in premium payments and death benefits, and its cash value growth is linked to an interest rate that can fluctuate. The cash value in these policies represents a savings component that grows on a tax-deferred basis, serving as the foundation for a policy loan.

How Life Insurance Loans Work

A life insurance loan is taken against the policy’s cash value, drawing funds from the policy’s own reserves. The cash value acts as collateral for the loan. This arrangement allows the policy to remain in force while the policyholder accesses liquidity.

Interest accrues on the outstanding loan balance, and the specific rate is outlined in the policy contract, often ranging from 5% to 8% or tied to a variable index. While the loan is outstanding, the portion of the cash value securing the loan may not earn interest or dividends at the same rate as the unencumbered portion. This can potentially slow the overall growth of the policy’s cash value.

Any outstanding loan balance, including accrued interest, directly reduces the death benefit paid to beneficiaries upon the policyholder’s passing. Life insurance loans are not considered taxable income when initially taken, as they are viewed as a withdrawal of the policyholder’s basis. However, if the policy lapses or is surrendered with an outstanding loan balance, the loan amount exceeding the policy’s cost basis may become taxable income under Internal Revenue Code Section 72.

Applying for a Policy Loan

Initiating a life insurance loan involves contacting the insurance provider directly. Policyholders can reach out through the insurer’s customer service line, access an online policy portal, or consult with their financial advisor. This contact helps determine the available loan amount based on the policy’s cash surrender value.

Policyholders need to provide their policy number, the specific loan amount desired, and banking details for direct deposit of the funds. Some insurers may require the completion of a specific loan request form to formalize the application. The insurer will then verify the policy’s cash value to ensure the requested loan amount falls within permissible limits, which is 90% to 95% of the accumulated cash value.

Forms can be submitted online, via email, mail, or fax, with digital submissions offering faster processing. Once the request is approved, funds are disbursed within a few business days, ranging from three to seven days. The policyholder receives a confirmation detailing the loan terms and disbursement information.

Repayment and Policy Implications

Repaying a life insurance loan offers significant flexibility, as there is no fixed repayment schedule or mandatory monthly payments. Policyholders can choose to repay the loan at their own pace, make irregular payments, or simply pay the accruing interest. This flexibility distinguishes policy loans from conventional loans.

Unpaid interest adds to the outstanding loan balance, causing the loan to grow over time through compounding. This can lead to a significant erosion of the policy’s cash value, reducing its long-term growth potential. A major risk arises if the total outstanding loan balance, including accrued interest, eventually exceeds the policy’s remaining cash value, which can cause the policy to lapse and coverage to terminate.

If a policy lapses with an outstanding loan, the loan amount that exceeds the policy’s cost basis becomes taxable income to the policyholder in the year of the lapse. This unexpected tax liability is a direct consequence under Internal Revenue Code Section 72. Any unrepaid loan balance, including accrued interest, is directly subtracted from the death benefit paid to beneficiaries, reducing the amount they receive.