How Can I Borrow Money From My Life Insurance Policy?

Life insurance policies can offer more than just a death benefit; certain types allow policyholders to access accumulated funds during their lifetime. This option involves borrowing money from the policy’s cash value. Unlike conventional loans from banks or other financial institutions, these are not dependent on credit checks or income verification. Instead, the policy itself serves as collateral for the loan. This provides financial flexibility, allowing policyholders to leverage their policy’s value without liquidating other assets.

Qualifying Life Insurance Policies

The ability to borrow from a life insurance policy requires a “cash value” component. Cash value is a portion of premium payments that accumulates over time, functioning as a savings or investment element within the policy. This accumulated cash value grows on a tax-deferred basis, meaning earnings are not taxed until they are withdrawn.

Cash value is primarily found in permanent life insurance policies, which cover the policyholder’s entire life. The main types of permanent life insurance that build cash value include Whole Life, Universal Life, and Variable Universal Life policies. Whole Life insurance offers guaranteed cash value growth at a fixed interest rate. Universal Life insurance provides flexibility, allowing adjustments to premiums and death benefits, with cash value growth tied to an interest rate.

Variable Universal Life insurance allows policyholders to invest cash value in various sub-accounts (e.g., stocks, bonds), offering potential for higher growth but also carrying investment risk. Term life insurance, by contrast, does not typically accumulate cash value and therefore cannot be borrowed against. It generally takes several years for a permanent life insurance policy to accumulate sufficient cash value for a loan, typically two to ten years.

Initiating a Policy Loan

To obtain a loan from a life insurance policy, policyholders typically contact their insurance company or agent. Many insurers offer online portals where policyholders can check their available cash value and initiate a loan request. This process is straightforward because the policy’s cash value acts as collateral, eliminating a lengthy approval process.

The amount a policyholder can borrow is usually a percentage of the policy’s cash value, commonly up to 90%. For instance, if a policy has $10,000 in cash value, the policyholder might be able to borrow up to $9,000. The insurer determines the maximum loan amount based on policy terms and the available cash surrender value (cash value minus fees or charges). Once the request is submitted and confirmed, funds can be disbursed quickly, sometimes within days.

How Policy Loans Operate

Once initiated, a policy loan functions differently from traditional loans. The money borrowed does not come directly from the policy’s cash value; instead, the insurer lends the money using the cash value as collateral. This means the policy’s cash value continues to grow and earn interest or dividends, even while the loan is outstanding. Interest accrues on the loan balance, with typical rates ranging from 5% to 8%, which can be fixed or variable depending on the policy. This interest is generally not tax-deductible.

Policy loans offer significant repayment flexibility, often without a strict schedule. Policyholders can choose to repay the loan in a lump sum, make partial payments, or even pay only the interest. If the loan and accrued interest are not repaid, the outstanding balance will reduce the death benefit paid to beneficiaries. If the loan amount plus accrued interest exceeds the policy’s cash value, the policy can lapse, leading to loss of coverage. Maintaining sufficient cash value to cover loan interest and making premium payments prevents policy lapse.

Tax Considerations for Policy Loans

Life insurance policy loans are generally tax-free transactions, viewed as a loan against the policy’s cash value rather than taxable income. This tax-favored treatment remains as long as the policy remains in force. The IRS does not consider these amounts taxable income when the policy is active and premiums are paid.

However, certain circumstances can trigger a taxable event. If the policy lapses or is surrendered with an outstanding loan balance, the loan amount exceeding the policyholder’s “basis” (total premiums paid into the policy) can become taxable income. This is because the IRS may view the loan as an unrepaid distribution. For Modified Endowment Contracts (MECs), policy loans are treated as distributions and may be subject to different tax rules, including potential taxation and a 10% penalty on gains if taken before age 59½. Monitoring the loan balance relative to the policy’s basis is important to avoid unintended tax consequences.