How to Take a Loan Out of Life Insurance

Life insurance policies can serve as a financial resource, allowing policyholders to access funds through a loan. This option provides a way to tap into a policy’s accumulated value while keeping the coverage in force. Understanding the process and implications of such a loan is important for policyholders considering this financial avenue.

Types of Life Insurance Policies that Allow Loans

Policy loans are exclusively available from permanent life insurance policies, which are designed to build cash value over time. Common examples of these policies include whole life, universal life, and variable universal life insurance.

The cash value component is a portion of the premium payments that grows on a tax-deferred basis, creating a savings element within the insurance contract. This accumulated cash value is what serves as the basis for a policy loan.

As premiums are paid and the policy matures, the cash value steadily increases, providing a growing reservoir from which a loan can be drawn. Term life insurance policies, by contrast, do not accumulate cash value and therefore do not offer the option for policy loans.

How Life Insurance Loans Work

A loan from a life insurance policy is not a direct withdrawal from the policy’s cash value. Instead, the insurance company lends the policyholder money, using the policy’s cash value as collateral for the loan. This arrangement means that the cash value continues to accrue interest or dividends, even while the loan is outstanding, although the rate of growth might be adjusted based on the loan terms.

The insurer charges interest on the loan, which typically accrues and is added to the outstanding loan balance if not paid periodically. These loans are generally not considered taxable income as long as the policy remains in force and the loan amount does not exceed the policy’s cost basis, which is typically the total premiums paid into the policy.

If the insured individual passes away with an outstanding loan balance, the death benefit paid to beneficiaries will be reduced by the amount of the loan, including any accrued interest.

Requesting a Loan

Initiating a loan request from a life insurance policy involves contacting the insurance company. Policyholders can reach out via customer service, through their insurance agent, or an online policy portal.

The company will guide the policyholder through the requirements and forms needed to process the loan. To facilitate the request, the policyholder will need to provide information such as the policy number, the desired loan amount, and personal identification details.

The process involves completing a loan request form. After verification, funds are disbursed through direct deposit or a check.

Managing and Repaying Your Loan

Policyholders have several options for managing and repaying borrowed funds. They can choose to make regular payments of principal and interest, or make a lump-sum repayment at any time. Policyholders can also allow the loan balance, including accrued interest, to continue growing without making active payments.

Choosing not to repay the loan carries significant consequences for the policy. The outstanding loan balance and accumulated interest will directly reduce the death benefit paid to beneficiaries. A risk is the potential for the policy to lapse if the outstanding loan amount, combined with accrued interest, grows to exceed the policy’s cash value.

If the policy lapses under these conditions, the loan amount up to the policy’s cost basis may become taxable income to the policyholder, potentially triggering an unexpected tax liability. Policyholders should regularly review their annual policy statements or contact their insurer to monitor their loan balance and understand the specific terms that could lead to a policy lapse.