What Life Insurance Can I Borrow Against?

Life insurance primarily provides a financial safety net for loved ones. Beyond the death benefit, certain types of life insurance policies offer cash value accumulation. This component builds funds over time, creating a living benefit accessible during the policyholder’s lifetime. Understanding how this cash value grows and can be utilized is key to leveraging life insurance as a financial tool.

Types of Life Insurance Supporting Loans

Only life insurance policies that accumulate cash value can be borrowed against, distinguishing them from policies solely providing a death benefit. These permanent policies allocate a portion of each premium payment towards this cash value, which grows on a tax-deferred basis. The specific growth mechanism and flexibility vary among policy types.

Whole life insurance offers guaranteed cash value growth at a fixed interest rate, with fixed premiums and a guaranteed death benefit. This predictability makes it a straightforward option for building accessible cash value over time. Policyholders can rely on a consistent increase in their policy’s savings component.

Universal life insurance provides more flexibility, allowing adjustments to premiums and death benefits within certain limits. Its cash value grows based on a declared interest rate, which can fluctuate but often comes with a guaranteed minimum. This adaptability benefits individuals with changing financial circumstances.

Variable universal life insurance offers the potential for higher cash value growth, as the cash value is invested in various sub-accounts, similar to mutual funds. This policy type allows for flexible premiums and death benefits, but the cash value fluctuates with market performance. Policyholders assume investment risk, meaning value can increase or decrease based on investments.

In contrast, term life insurance does not build cash value, providing coverage for a specific period (e.g., 10, 20, or 30 years). Without a savings component, term life policies cannot be borrowed against. They are generally more affordable than permanent policies, focusing solely on the death benefit.

How Policy Loans Work

Taking a loan against a life insurance policy differs significantly from a traditional bank loan. Policyholders borrow from the insurance company, using accumulated cash value as collateral. The loan is secured by the policy’s own funds.

The insurance company charges interest on policy loans, which can be fixed or variable, typically 4% to 8%. While interest accrues on the borrowed amount, the remaining cash value within the policy generally continues to grow. This allows the policy’s savings component to still earn interest or dividends, even with an outstanding loan.

Policy loans feature a flexible repayment structure. Unlike conventional loans, there are no strict repayment schedules, mandatory monthly payments, or fixed due dates. Policyholders can repay at their own pace, make interest-only payments, or allow interest to accrue and be added to the loan balance.

This flexibility provides financial control, allowing policyholders to manage cash flow without rigid debt obligations. However, monitoring the loan balance is important, as accruing interest can increase the total amount owed. The loan amount can be up to 90% or 95% of the policy’s cash value.

Implications of Taking a Policy Loan

While policy loans offer flexibility, they carry implications for the policy and its beneficiaries, especially if not repaid. The most direct consequence is a reduced death benefit. Any outstanding loan balance, plus accrued interest, will be deducted from the death benefit paid to beneficiaries.

An outstanding loan can also risk policy lapse. If the loan balance, including accumulating interest, exceeds the policy’s cash value, the policy may terminate. Should a policy lapse with an unpaid loan, the amount exceeding premiums paid can become a taxable event.

The Internal Revenue Service (IRS) may consider the loan portion exceeding the policyholder’s cost basis (total premiums paid minus any dividends received) as taxable income. Policyholders receive a Form 1099-R from the insurer for this amount. Managing the loan and paying at least the interest annually helps prevent the loan from growing too large and jeopardizing the policy’s in-force status.

Interest continues to accrue on the policy loan as long as it remains unpaid. This ongoing accumulation can erode the policy’s cash value and, consequently, the death benefit. Regular monitoring of the loan balance and considering repayment strategies are prudent steps to ensure the policy meets its intended purpose of providing financial security.