How Can I Borrow From My Life Insurance Policy?

A life insurance policy represents a financial asset that can offer more than just a death benefit to beneficiaries. For policyholders, it can serve as a source of funds during their lifetime through a policy loan. This mechanism allows individuals to access a portion of their policy’s accumulated value to address various financial needs.

Understanding how this process works, from the types of policies that qualify to the implications of borrowing, is important for those considering leveraging their life insurance for immediate financial requirements. This option can provide a flexible source of liquidity without the need for traditional loan applications or credit checks, distinguishing it from other borrowing avenues. It offers a unique way to utilize the policy’s value while the coverage remains in force.

Policy Types That Allow Borrowing

Accessing funds through a life insurance policy loan is contingent upon the policy accumulating a feature known as cash value. This cash value component is a savings or investment element built into certain types of life insurance policies. As premiums are paid, a portion of these payments contributes to the growth of this cash value over time.

Permanent life insurance policies are the primary types that offer this cash value accumulation feature. This category includes policies such as Whole Life, Universal Life, and Variable Universal Life.

In contrast, term life insurance policies typically do not accumulate cash value. Term insurance provides coverage for a specific period, such as 10, 20, or 30 years, and is generally designed to offer a death benefit only if the insured passes away within that defined term. Term life insurance policies do not allow for policy loans.

Understanding a Policy Loan

A life insurance policy loan operates distinctly from a traditional loan obtained from a bank or credit union. When a policyholder takes a loan, they are not withdrawing money directly from their policy’s cash value. Instead, the insurance company lends the policyholder funds, using the policy’s accumulated cash value as collateral for the loan. This means the cash value remains within the policy, continuing to grow, while the loan is secured against it.

Interest accrues on the outstanding loan balance, similar to other forms of debt. The interest rates are typically set by the insurer and can be either fixed or variable, depending on the specific policy terms. Unpaid interest is added to the loan balance, causing the total amount owed to increase.

An outstanding policy loan directly reduces the death benefit payable to beneficiaries. If the policyholder passes away with an unpaid loan balance, the amount of the loan plus any accrued and unpaid interest is deducted from the death benefit before it is distributed. This reduction ensures that the loan is repaid from the policy’s proceeds. Additionally, if the loan balance, including accrued interest, grows to exceed the policy’s cash value, the policy can lapse, which may trigger significant financial consequences.

One important characteristic of life insurance policy loans is their tax treatment. Generally, policy loans are not considered taxable income as long as the policy remains in force. However, if the policy lapses or is surrendered with an outstanding loan, the loan amount, up to the amount of gain in the policy, could become taxable income. This potential tax implication arises because the original loan was not taxed, and a lapse effectively converts the loan into a distribution.

Steps to Obtain a Policy Loan

Securing a policy loan typically begins with contacting the issuing insurance company. Policyholders can generally initiate this process through various channels, including calling the insurer’s customer service, accessing an online policyholder portal, or consulting with their financial advisor or insurance agent. The method of contact may vary depending on the insurance company’s specific procedures and available services.

Upon contact, the policyholder will need to provide essential information, such as their policy number and the desired loan amount. The insurance company will then verify that the policy has sufficient cash value to support the requested loan. Most insurers allow borrowing up to a certain percentage of the accumulated cash value, often up to 90% or 95%.

The next step involves completing the necessary documentation. This usually entails filling out a loan request form provided by the insurance company, which may require the policy owner’s signature. Some companies may offer digital forms or online submission processes to streamline this step. Once the completed form is submitted, the insurance company reviews the request.

After approval, the loan funds are typically disbursed within a few business days. While some sources suggest funds can be available in a matter of days, it generally takes an estimated 3 to 5 business days for the funds to be processed and sent to the policyholder. The specific timeline can depend on the insurer’s processing speed and the chosen disbursement method, such as direct deposit or a mailed check.

Managing Your Policy Loan

After obtaining a life insurance policy loan, policyholders have flexibility regarding repayment, as these loans typically do not have a fixed repayment schedule. While there is no mandatory payment timeline, policyholders can choose to repay the loan in a lump sum, make periodic payments of principal and interest, or pay only the accrued interest. Regular payments are often recommended to prevent the loan balance from growing due to compounding interest. Failing to repay the loan and its accumulating interest can have significant consequences for the policy.

An outstanding loan can also affect the policy’s future performance and growth. While the cash value typically continues to earn interest or dividends even with a loan, the net growth can be reduced due to the interest charged on the loan. This can diminish the long-term compounding effect and overall value of the policy. For policies that pay dividends, the presence of a loan may impact the dividend payout.