How to Take Out a Loan on Your Life Insurance

Life insurance serves as a foundational financial instrument, offering protection for beneficiaries in the event of the policyholder’s passing. Beyond its primary role of providing a death benefit, certain life insurance policies possess a unique feature that allows policyholders to access accumulated funds during their lifetime. This accessibility comes in the form of a loan, leveraging the policy’s inherent value. This article will guide readers through the process of obtaining and managing such a loan, clarifying its mechanics and implications.

Understanding Life Insurance Loans

A life insurance loan is an advance provided by the insurance company, using the accumulated cash value within the policy as collateral. Unlike conventional loans, there is no credit check or lengthy approval process.

Only permanent life insurance policies, which build cash value over time, are eligible for these loans. These include whole life insurance, universal life insurance, variable universal life insurance, and indexed universal life insurance. Term life insurance policies do not accumulate cash value and cannot be used to secure a loan. Cash value grows on a tax-deferred basis, providing an accessible pool of funds.

Interest, fixed or variable, accrues on the outstanding loan balance. Unlike traditional loans with rigid repayment schedules, policy loans offer flexibility, allowing policyholders to repay the loan at their own pace or even not at all. However, this flexibility has consequences for the policy.

Preparing to Request a Loan

Before requesting a loan, policyholders must ensure their policy meets eligibility criteria. The policy must be a permanent life insurance policy with sufficient accumulated cash value. It typically takes several years to build sufficient cash value for a loan, often two to ten years. The policy must also be in force, meaning all premiums are current.

Policyholders can determine their available loan amount by reviewing recent policy statements, which detail the current cash value. Insurers often allow borrowing up to 90% of the accumulated cash value. For instance, a policy with $10,000 in cash value might allow a $9,000 loan. If the available amount is unclear, contact the insurer or an agent for precise figures.

Specific information and documentation will be required. This includes the policy number, personal identification, and desired loan amount. While a credit check is not necessary, the insurer confirms identity and policy status. Loan application forms are available via the insurer’s website, customer service, or a licensed agent. Accurately completing the form with verified policy details and the desired loan amount will streamline the process.

The Loan Request and Disbursement Process

After completing the loan application, submit the request to the insurance company. Submission methods vary, including mailing, online portals, or faxing. Access to funds is easy because the policy’s cash value serves as collateral, eliminating the need for traditional credit approval.

After submission, the insurer reviews the request to confirm policy eligibility and sufficient cash value. Processing is generally swift, with funds often disbursed within days. This efficiency benefits from the loan being secured by the policy’s existing value.

Loan funds are typically disbursed via check or direct deposit. Upon approval and disbursement, the policyholder receives confirmation or additional documentation. This documentation may include a loan agreement outlining terms like the interest rate and repayment options, or an updated policy statement reflecting the new loan balance. These documents are important for tracking the loan and its policy impact.

Managing Your Life Insurance Loan

After receiving the loan, policyholders have flexibility in repayment and ongoing responsibilities. Interest accrues from the disbursement date and is added to the outstanding loan balance if unpaid. Unlike traditional loans, there is no fixed repayment schedule. Policyholders can pay interest only, make partial principal payments, or allow interest to capitalize onto the principal. Some policyholders may choose to make no repayments, allowing the loan balance and accrued interest to grow against the policy.

Allowing the loan balance to increase, especially if interest accrues, significantly impacts the policy’s cash value and death benefit. The outstanding loan, including accrued interest, directly reduces the death benefit paid to beneficiaries. If the total outstanding loan balance and accumulated interest exceed the policy’s cash value, the policy can lapse. A policy lapse due to an outstanding loan can terminate coverage and trigger adverse tax consequences.

Life insurance loans are generally tax-free, viewed as an advance against the policy’s cash value rather than taxable income. However, this tax-free status is contingent upon the policy remaining in force. If the policy lapses with an outstanding loan, or is surrendered, the loan amount exceeding premiums paid (cost basis) may become taxable income. If the policy is classified as a Modified Endowment Contract (MEC) under Internal Revenue Code Section 7702A, loans and withdrawals are treated differently, potentially subject to income tax and a 10% penalty if taken before age 59½. This classification occurs when a policy’s premiums exceed certain limits, causing it to lose favorable tax treatment.