How to Take a Loan From Life Insurance

A life insurance loan provides a way to access funds from a permanent life insurance policy during the policyholder’s lifetime. This financial tool allows individuals to tap into the accumulated cash value of their policy. Unlike traditional bank loans, these loans are secured by the policy’s own value, offering a unique borrowing mechanism.

Eligible Life Insurance Policies

Accessing a loan from a life insurance policy is exclusively available through policies that build “cash value.” This cash value is a savings component that accumulates over time within permanent life insurance policies. A portion of each premium payment contributes to this cash value, which then grows on a tax-deferred basis, similar to how interest accrues in a savings account.

Types of permanent life insurance policies that feature a cash value component include whole life, universal life, and variable universal life. Whole life insurance offers guaranteed cash value growth at a fixed interest rate, providing predictability. Universal life policies offer more flexibility with premiums and death benefits, and their cash value growth may be linked to market interest rates, often with a guaranteed minimum rate. Variable universal life insurance allows policyholders to invest the cash value in various investment options, such as stocks and bonds, offering potential for higher returns but also carrying investment risk.

In contrast, term life insurance policies do not build cash value. These policies provide coverage for a specific period, typically 10, 20, or 30 years, and primarily offer a death benefit without a savings component. The cash value within permanent policies grows steadily over the years. It generally takes several years for sufficient cash value to accumulate before a loan becomes a viable option.

How Life Insurance Loans Work

A loan from a life insurance policy is not a conventional loan from a financial institution; instead, it is an advance from the insurance company using the policy’s cash value as collateral. There is no need for a credit check, income verification, or external approval process.

Interest accrues on the loan balance, with rates ranging from 5% to 8%, which can be fixed or variable depending on the policy. While interest is charged, the cash value in the policy often continues to grow, potentially offsetting some of the interest cost. Policyholders have flexibility regarding repayment; there is no mandatory repayment schedule, and individuals can repay the loan at their own pace or even choose not to repay it at all.

An outstanding loan balance, along with any accrued interest, directly reduces the death benefit paid to beneficiaries upon the policyholder’s death. If the loan balance, including accumulated interest, grows to exceed the policy’s cash value, the policy can lapse, terminating coverage.

If a policy lapses with an outstanding loan, the borrowed amount that exceeds the premiums paid into the policy may become taxable income. The IRS treats the unpaid loan as a distribution, and any gain (cash value minus premiums paid) can be taxed as ordinary income. Loans are tax-free as long as the policy remains in force and does not lapse. However, if the policy is a Modified Endowment Contract (MEC), loans and withdrawals are taxed differently, with earnings being taxed first and potentially subject to a 10% penalty if the policyholder is under age 59½.

Steps to Request a Loan

Initiating a loan from your life insurance policy involves a straightforward process. The first step is to contact your insurance company directly. This can be done via phone, through their online portal, or by consulting with your financial advisor or agent. The insurer can confirm your policy’s eligibility and the amount of cash value available for a loan.

Next, you will need to provide information to facilitate the loan request. This includes your policy number and the desired loan amount. While the reason for the loan is not required by the insurer, having a clear purpose for the funds can help determine the appropriate amount to borrow. Most insurance companies allow policyholders to borrow up to 90% of their policy’s current cash value.

The insurer will provide a loan request form for you to complete. This form will require you to specify the loan amount and any repayment preferences, although a fixed repayment schedule is not mandated. Once the form is submitted, the insurance company processes the request. The funds are disbursed through direct deposit or by check. The timeline for receiving the funds can vary but takes a few business days to a few weeks, depending on the insurer’s processing times.