How Can I Borrow Money From My Life Insurance?

Life insurance can serve as a financial resource during your lifetime, beyond its primary function of providing a death benefit. Certain types of policies accumulate a cash value, which policyholders may access through a loan. This option provides financial flexibility, enabling access to funds without traditional loan application processes. Understanding how these loans function and their implications is important for those considering this financial avenue.

Policies That Allow Borrowing

The ability to borrow against a life insurance policy depends on whether it accumulates cash value. Permanent life insurance policies, such as whole life, universal life, and variable universal life, are designed with this feature. A portion of premiums paid into these policies contributes to a cash value account, which grows over time. This accumulated cash value serves as the basis for a policy loan.

Whole life insurance offers a fixed premium and a guaranteed death benefit, with its cash value growing at a set interest rate. Universal life insurance provides flexibility, allowing adjustments to premium payments and death benefits. Its cash value growth is often tied to market performance, though typically with a guaranteed minimum rate.

Variable universal life insurance links cash value growth to investment sub-accounts, offering potential for higher returns but also increased risk. Term life insurance policies do not build cash value, meaning they do not offer a borrowing feature. Only permanent life insurance policies with a cash value component can be used for policy loans.

How a Policy Loan Works

A life insurance policy loan is not a direct withdrawal of your cash value. It is a loan from the insurance company, with your policy’s cash value serving as collateral. The funds come from the insurer’s general account, and your policy’s cash value continues to grow, even while the loan is outstanding. This arrangement allows your cash value to remain intact, providing security for the loan.

Policy loans are accessible. No credit check or income verification is required. As long as your policy has accumulated sufficient cash value, you can request a loan for any reason, with funds often available within days. Most insurers allow borrowing up to 90% of the policy’s cash value, though this percentage can vary.

Unlike traditional loans, policy loans do not have a fixed repayment schedule. You have the flexibility to repay the loan at your own pace, with options ranging from lump-sum payments to smaller, regular installments, or even choosing not to repay the principal during your lifetime. Interest accrues on the outstanding loan balance and is added to the loan amount if not paid periodically. Interest rates for policy loans are generally competitive, often ranging between 5% and 8%, and can be lower than those for personal loans or credit cards.

While the cash value continues to grow, an outstanding loan reduces the available cash value for other purposes, such as withdrawals or surrenders. The loan balance, including accrued interest, directly offsets the portion of the cash value that can be accessed. Monitoring the loan balance is important, as excessive growth due to unpaid interest can impact the policy’s future.

Impact on Policy Values and Benefits

Taking a policy loan has direct financial consequences, particularly if not repaid. The most immediate effect is a reduction in the death benefit paid to beneficiaries. If a loan, along with any accrued interest, is outstanding at the insured’s death, the insurance company will deduct the total owed from the death benefit. This means beneficiaries will receive a smaller payout than the policy’s face value.

A risk with unpaid policy loans is the potential for policy lapse. If the outstanding loan balance, combined with accrued interest, grows to exceed the policy’s cash surrender value, the policy can lapse. When a policy lapses with an outstanding loan, it terminates coverage, meaning no death benefit is paid. This can also trigger adverse tax implications for the policyholder.

If a policy lapses with an outstanding loan, the loan amount may become taxable income to the extent it exceeds the premiums paid into the policy. The IRS may treat the loan as a distribution from the policy, and any gain (the difference between the cash value and the premiums paid) could be subject to ordinary income tax.

Repaying the loan helps restore the policy’s full death benefit and allows the cash value to continue growing unencumbered. Conversely, non-repayment can lead to compounding interest, which further erodes the policy’s cash value and increases the risk of lapse, ultimately diminishing the financial protection intended for beneficiaries.