How Can I Borrow From My Life Insurance?

Life insurance policies can offer a unique financial resource beyond providing a death benefit. Certain types of these policies accumulate a cash value over time, which policyholders may be able to access through a loan. These policy loans provide a way to obtain funds without traditional credit checks or external lending institutions. Understanding the structure and implications of these loans is important for policyholders considering this option.

Policies with Loan Capabilities

Only permanent life insurance policies are designed to build a cash value component, which serves as the source for policy loans. This category primarily includes whole life and universal life insurance policies. These policies allocate a portion of premium payments to a cash value account, which grows on a tax-deferred basis over the life of the policy.

In contrast, term life insurance policies do not accumulate cash value and therefore do not offer any loan options. Term policies are designed to provide coverage for a specific period, and premium payments primarily cover the cost of insurance for that term.

The accumulated cash value acts as collateral for the loan, meaning the loan is essentially taken against your own policy’s value rather than from the insurer’s general funds. This distinction is important because it means the loan does not require a credit check or approval based on your financial history.

Understanding Policy Loan Terms

The amount a policyholder can borrow is typically a percentage of the policy’s cash surrender value, rather than the full cash value. Insurers commonly allow loans up to 90% or more of the cash surrender value, which accounts for any surrender charges that might apply if the policy were terminated. The specific percentage is determined by the individual insurance company and policy contract.

Interest is charged on policy loans, and this interest accrues whether or not regular repayments are made. The interest rate can be either fixed or variable, often competitive with other forms of credit, and is specified within the policy contract. This accrued interest adds to the outstanding loan balance, increasing the amount that would be deducted from the death benefit if the loan is not repaid.

Unlike traditional bank loans, policy loans typically do not have a strict repayment schedule. Policyholders have considerable flexibility regarding when and how much to repay, or they can choose not to repay the loan at all. Despite this flexibility, the outstanding loan balance, including accrued interest, continues to grow.

How Policy Loans Affect Your Insurance

An outstanding policy loan, along with any accrued interest, directly reduces the death benefit paid to beneficiaries. When the policyholder passes away, the insurer will deduct the total outstanding loan amount from the death benefit before distributing the remaining funds. This reduction ensures the loan is repaid and affects the financial legacy intended for beneficiaries.

An outstanding loan can also introduce a risk of policy lapse, particularly if the loan balance, including interest, grows to exceed the policy’s cash value. If this occurs, and sufficient premium payments are not made to restore the cash value, the policy may terminate. This situation can leave the policyholder without coverage and potentially facing tax implications.

If a policy lapses or is surrendered while an outstanding loan exists, any portion of the loan amount that exceeds the total premiums paid into the policy may be considered taxable income. This is because the IRS views the excess amount as a distribution of untaxed gains from the policy. Policyholders should consult with a tax advisor to understand the specific tax consequences of a policy lapse with an outstanding loan. Furthermore, the portion of the cash value used for the loan typically ceases to earn interest or dividends. This can slow the overall growth of the policy’s cash value, impacting its long-term accumulation potential.

Steps to Obtain a Policy Loan

To initiate a policy loan, the first step involves contacting your life insurance company or a licensed agent. They can provide specific details regarding your policy’s cash value and loan eligibility. It is important to confirm the current cash surrender value available for borrowing.

The insurer will then verify the policy’s cash value and inform you of the maximum loan amount you can access. Next, you will usually need to complete specific application forms provided by the insurance company. These forms typically require basic information, the desired loan amount, and your signature to authorize the transaction.

Once the application is processed and approved, the funds are typically disbursed through common methods such as direct deposit into your bank account or by check. The time frame for receiving funds can vary but is often within a few business days to a week. While repayment is flexible, the insurer will provide information on various methods for making repayments if you choose to do so.