How to Take a Loan From Your Life Insurance

Life insurance policies can offer more than just a death benefit; certain types allow policyholders to access funds during their lifetime through policy loans. These loans leverage the accumulated cash value within the policy, providing a flexible financial resource without requiring liquidation of the policy itself. This option can be appealing for various financial needs, allowing access to accumulated value while maintaining coverage.

Understanding Loan-Eligible Life Insurance Policies

Cash value refers to a component within certain life insurance policies that grows over time and can be accessed by the policyholder. A portion of each premium payment contributes to this cash value, which accumulates on a tax-deferred basis.

Permanent life insurance policies, such as whole life, universal life, variable universal life, and indexed universal life, are designed to build cash value. Whole life insurance typically guarantees a fixed rate of cash value growth, and some policies may also be eligible for dividends. Universal life policies offer more flexibility in premiums and death benefits, with cash value growth often tied to a variable interest rate or market index. Variable universal life and indexed universal life policies allow the cash value to be invested, offering potential for higher returns but also carrying greater risk.

A policy loan is taken against this accumulated cash value, meaning the cash value serves as collateral for the loan from the insurance company. It is not a withdrawal of your own money from the policy, so the cash value typically continues to grow even with an outstanding loan. This means the policy remains in force, and the cash value can continue to earn interest or investment gains. In contrast, term life insurance policies do not build cash value and therefore do not offer the option of taking a policy loan.

Determining Loan Eligibility and Terms

Before initiating a loan request, policyholders should understand the specific terms and eligibility criteria of their individual policy. The maximum available loan amount is typically a percentage of the policy’s accumulated cash value, often up to 90%. Newer policies may not have sufficient cash value built up to allow for a significant loan.

Loan interest rates can vary and may be either fixed or variable, depending on the specific policy and insurer. These rates, often ranging from 5% to 8%, are generally competitive compared to other personal loans. The interest typically accrues on the unpaid balance. Some insurers might also have administrative fees associated with processing a loan, which should be clarified beforehand.

Policyholders can find this detailed information within their policy documents, which outline the terms and conditions for loans. For clarification or specific current figures, contacting the insurance agent or the company’s customer service department is advisable.

Applying for a Life Insurance Loan

Once the policyholder has determined their eligibility and understood the specific loan terms, the process of applying for a life insurance loan is generally straightforward. The first step involves initiating contact with the life insurance company. This can typically be done through various channels, such as a phone call to customer service, logging into an online policyholder portal, or sending a written request via mail.

Upon contact, the insurer will guide the policyholder on how to obtain and complete the necessary loan application form. The application will usually request basic information, including the desired loan amount and the preferred method for fund disbursement, such as direct deposit into a bank account or a physical check.

Since the policy’s cash value serves as collateral, a credit check or extensive approval process is typically not required for a life insurance loan, simplifying the application. After the application is submitted, the timeline for loan processing and fund disbursement can vary, but funds are often received within a matter of days or a few weeks.

Managing Your Life Insurance Loan

Managing a life insurance loan involves understanding its ongoing implications for the policy and potential tax consequences. Policy loans typically offer significant repayment flexibility, meaning there are often no fixed repayment schedules or penalties for non-payment. However, interest continues to accrue on the outstanding loan balance.

Unpaid interest is usually added to the principal balance of the loan, causing the total outstanding loan amount to grow over time. This increasing loan balance directly impacts the policy’s death benefit; any outstanding loan, including accrued interest, will reduce the amount paid to beneficiaries upon the policyholder’s death. For example, if a policy has a $250,000 death benefit and an outstanding loan of $50,000, the beneficiaries would receive $200,000.

A significant risk of an unmanaged loan is policy lapse. If the accumulating loan balance, including interest, grows to exceed the policy’s cash value, the insurance company may terminate the policy. This can result in the loss of coverage and any remaining cash value.

Tax implications are also a consideration. Generally, life insurance loans are not taxable as long as the policy remains in force and is not classified as a Modified Endowment Contract (MEC). However, if a policy lapses or is surrendered with an outstanding loan, the loan amount that exceeds the policyholder’s cost basis (total premiums paid minus dividends) could become taxable income.

If a policy is classified as a Modified Endowment Contract (MEC) under IRS rules (IRC Section 7702A), loans and withdrawals are taxed differently. For MECs, any distributions, including loans, are generally treated as taxable income on a “last-in, first-out” (LIFO) basis, meaning earnings are taxed first. Additionally, if the policyholder is under age 59½, a 10% federal penalty tax may apply to the taxable portion of the loan, similar to early withdrawals from retirement accounts.

Policyholders have several repayment strategies available, including making regular payments, paying only the interest to prevent the loan balance from growing, or allowing the loan to remain outstanding and reduce the death benefit. Consistent monitoring of the loan balance relative to the cash value is important to prevent unintended policy lapse or significant reduction of the death benefit.