What Life Insurance Policies Can You Borrow From?

Certain life insurance policies allow policyholders to access accumulated value during their lifetime. This ability to tap into the policy’s value offers financial flexibility, though it is not a universal characteristic of all life insurance products.

Life Insurance Policies with Borrowing Capabilities

Only life insurance policies that build a cash value component permit policyholders to borrow against them. Cash value is a savings feature that grows over time within the policy, accumulating funds that can be accessed while the insured is still alive.

Term life insurance offers coverage for a specific period, such as 10, 20, or 30 years, and does not accumulate a cash value. Consequently, term policies do not provide borrowing capabilities. Their primary function is to provide a death benefit if the insured passes away within the specified term.

Permanent life insurance policies, designed to provide coverage for the insured’s entire life, include a cash value component. Whole life insurance offers guaranteed cash value growth at a predictable interest rate and features fixed premiums. The cash value in a whole life policy builds steadily over the years, with part of each premium payment contributing to this accumulation.

Universal life insurance provides more flexibility in premiums and death benefits compared to whole life. Its cash value grows based on interest rates set by the insurer or linked to market performance, often with a guaranteed minimum interest rate. Policyholders can adjust premium payments within certain limits, and the cash value can be used to cover policy costs.

Variable universal life insurance (VUL) links cash value growth to the performance of underlying investment sub-accounts. This offers the potential for higher returns but carries investment risk, meaning the cash value can fluctuate and decrease with poor market performance. VUL policies provide flexibility in adjusting premiums and death benefits, similar to universal life.

Indexed universal life insurance (IUL) ties cash value growth to a market index without directly investing in the market. IUL policies have a minimum guaranteed interest rate, or “floor,” to protect against market downturns, and a “cap” that limits the maximum interest earned during periods of high market growth. This structure offers a balance between growth potential and risk protection, with flexible premiums.

Understanding Life Insurance Loans

A loan taken from a life insurance policy is not a withdrawal of the cash value itself, but a loan against the policy’s accumulated cash value. The cash value serves as collateral, and the policy remains in force as long as premiums are paid and sufficient cash value remains. Policy loans do not typically require a credit check or lengthy approval, as the policy’s cash value secures the loan.

Interest accrues on the loan balance, with rates that can be fixed or variable, depending on policy terms. While repayment of the loan principal is optional, interest payments are expected. If interest payments are not made, unpaid interest is added to the loan balance, causing it to grow.

An outstanding loan balance, including accrued interest, directly reduces the death benefit paid to beneficiaries. For example, if a policy has a $250,000 death benefit and a $50,000 outstanding loan, beneficiaries would receive $200,000. If the loan plus accrued interest exceeds the policy’s cash value, the policy can lapse, terminating coverage.

Important Considerations for Policy Loans

An outstanding life insurance policy loan directly impacts the death benefit, as the loan balance and any accrued interest are deducted from the payout to beneficiaries. Policyholders should monitor their loan balance to prevent this outcome.

The potential for a policy to lapse is a consideration if a loan is not managed properly. If the loan balance, including interest, grows to exceed the policy’s cash value, the insurance company may terminate the policy. When a policy lapses with an outstanding loan, the loan amount exceeding the premiums paid into the policy (the cost basis) can become taxable income. This can result in an unexpected tax bill, even if the policyholder did not directly receive additional cash.

The interest charged on a policy loan can affect the policy’s overall cash value growth. While the cash value continues to earn interest, the loan interest can offset or outpace this growth if left unpaid. This can slow cash value accumulation, impacting future access to funds or the policy’s long-term financial performance.

Understanding the terms and conditions of a policy loan is important. While repayment schedules are often flexible, making regular interest payments or partial principal payments helps preserve the policy’s integrity and prevents the loan from growing unmanageably large.