How to Borrow Money From Life Insurance

Accessing funds from a life insurance policy through a loan functions as an advance against the accumulated value within the policy itself. Policyholders can tap into their policy’s value while keeping coverage in force, providing a flexible financial resource.

Understanding Policy Loan Eligibility

Not all life insurance policies allow for loans. Eligibility for a policy loan depends on the type of life insurance held, specifically whether it accumulates cash value. Permanent life insurance policies, such as whole life and universal life, include a savings component that grows over time. This cash value is the portion of the policy that can be accessed through loans or withdrawals.

Term life insurance policies do not build cash value. They provide a death benefit for a specific period and do not offer borrowing options. For a loan to be possible, a permanent policy must have accumulated sufficient cash value, which takes several years of premium payments.

How Life Insurance Policy Loans Work

When a policyholder takes a loan, they borrow from the accumulated cash value within their policy. The cash value serves as collateral, and the insurance company provides the funds. This process does not require a credit check or a formal loan application.

Interest accrues on the outstanding loan balance. While the loan is active, the policy’s cash value continues to grow, earning interest or dividends. Any unpaid loan balance, including accrued interest, will reduce the death benefit paid to beneficiaries. There is no strict repayment schedule, but consistent interest payments are necessary to prevent the loan from growing too large.

Steps to Request a Policy Loan

Obtaining a policy loan involves a few steps once sufficient cash value has accumulated. First, identify the current cash value available in your permanent life insurance policy. Insurance companies allow borrowing up to a certain percentage, such as 90%, of the policy’s cash value.

Next, contact your insurance provider directly. This can be done through a phone call, an online portal, or by submitting a loan request form. You will need to provide your policy number and the desired loan amount.

Managing and Repaying Your Policy Loan

Managing a policy loan helps maintain the policy’s integrity. Policyholders have flexibility regarding repayment, with options including regular payments, sporadic payments, or only paying accrued interest. Some may choose not to repay the principal during their lifetime.

An outstanding loan balance directly reduces the death benefit that will be paid to beneficiaries upon the insured’s passing. If the loan, plus any accrued interest, grows to exceed the policy’s cash value, the policy can lapse, leading to a loss of coverage. Monitoring the loan balance and making at least interest payments helps prevent this outcome and ensures the policy remains in force.

Tax Implications of Policy Loans

Policy loans are not considered taxable income as long as the life insurance policy remains active. This is because the loan is viewed as debt against your own asset, not as a distribution of earnings. However, exceptions exist where tax implications can arise.

If the policy lapses or is surrendered with an outstanding loan, the loan amount may become taxable income up to the policy’s gain. Policies designated as Modified Endowment Contracts (MECs) have different tax rules. Loans from MECs are treated as taxable distributions on a “last-in, first-out” (LIFO) basis, meaning gains are taxed first, and may be subject to a 10% federal penalty if the policyholder is under age 59½.