What Insurance Policy Can You Borrow From?

Certain types of insurance policies offer a unique way to access funds. This involves borrowing money against the accumulated cash value within a policy. While not all insurance products offer this feature, those that do provide policyholders with a potential source of liquidity, distinguishing them from policies solely focused on protection.

Policies That Allow Borrowing

The ability to borrow from an insurance policy is tied to policies that accumulate cash value, generally permanent life insurance products. These policies build a savings component over time, distinct from the death benefit. Term life insurance policies, designed purely for protection over a specific period, do not accumulate cash value and therefore do not allow for borrowing.

Whole life insurance is a common type of permanent policy known for its guaranteed cash value growth and fixed premiums. A portion of each premium payment contributes to this cash value, which grows at a guaranteed interest rate. Policyholders can borrow against this accumulated value once it reaches a sufficient level.

Universal life insurance offers more flexibility than whole life, allowing policyholders to adjust premiums and death benefits within certain limits. Its cash value component grows based on an interest rate, which may be fixed or variable. Policyholders can access these funds through loans.

Variable universal life insurance includes an investment-linked cash value component. Its growth depends on the performance of underlying investment options, such as stocks or bonds, introducing higher growth potential and greater risk. Policy loans can be taken against this fluctuating value, though poor investment performance could impact the available loan amount or risk the policy’s viability.

Indexed universal life insurance, a variation, ties its cash value growth to a market index, offering potential for higher returns while often providing some protection against market downturns. These policies also permit loans against their cash value.

How Policy Loans Operate

A policy loan functions as a loan from the insurance company, using the policy’s cash value as collateral, rather than a direct withdrawal. The cash value continues to accrue interest or dividends, although net growth might be affected by the loan’s interest rate. The loan amount is limited to a percentage of the cash value, often up to 90%.

Interest is charged on policy loans, with rates ranging from 5% to 8%, which can be fixed or variable depending on the policy and insurer. This interest accrues annually and, if not paid, can be added to the outstanding loan balance, causing it to grow.

Policy loans offer significant repayment flexibility, unlike traditional bank loans. There is no fixed repayment schedule, allowing policyholders to repay the loan at their convenience, or not at all, as long as the policy remains in force. Any outstanding loan balance, including accrued interest, will reduce the death benefit paid to beneficiaries upon the insured’s passing.

Key Factors When Considering a Policy Loan

A primary consideration is the impact on the death benefit. If a loan is not repaid, the outstanding balance, along with any accrued interest, is subtracted from the death benefit paid to the beneficiaries. This can significantly reduce the financial protection intended for loved ones.

There is a risk of policy lapse if the outstanding loan balance and accrued interest grow to exceed the policy’s cash value. Should this occur, the insurance company may terminate the policy, resulting in the loss of coverage. Such a lapse can trigger adverse tax consequences, as the unpaid loan amount exceeding the policy’s basis (premiums paid minus dividends received) may be considered taxable income by the Internal Revenue Service (IRS).

Policy loans do not require a credit check or a lengthy approval process. This is because the loan is secured by the policy’s own cash value, making it a readily accessible source of funds for eligible policyholders.

The funds obtained from a policy loan can be used for any purpose. While the loan proceeds are tax-free as long as the policy remains in force, it is important to manage the loan to prevent the policy from lapsing, which would then make the outstanding loan amount potentially taxable.