What Life Insurance Policies Can You Borrow From?

Life insurance policies provide a death benefit to beneficiaries upon the insured’s passing. Beyond this, certain policies offer a living benefit: the ability to access accumulated cash value during the policyholder’s lifetime. This allows policy owners to borrow funds, providing a flexible financial resource. Understanding which policies offer this capability and how these loans function is important for anyone considering life insurance as part of their financial strategy.

Policies That Allow Borrowing

The ability to borrow from a life insurance policy is directly tied to its cash value component. Not all policies build cash value, which is a savings element that grows over time. Policies that accumulate cash value are generally permanent life insurance, designed to provide coverage for the insured’s entire life.

Whole life insurance is a prominent example of a permanent policy that builds cash value. A portion of each premium payment is allocated to this cash value, which grows at a guaranteed rate set by the insurer. This consistent growth, often supplemented by dividends, creates a predictable sum that policyholders can access. Whole life policies are characterized by fixed premiums and a guaranteed death benefit, assuming premiums are paid.

Universal life insurance is another permanent policy that accumulates cash value, offering more flexibility than whole life. Policyholders can adjust their premium payments and even the death benefit amount to suit their changing financial circumstances. The cash value grows based on interest rates set by the insurer or linked to market performance, though many policies include a guaranteed minimum interest rate.

Term life insurance policies do not build cash value. These policies provide coverage for a specific period, such as 10, 20, or 30 years. Since term life is designed purely for death benefit protection and lacks a savings component, it does not offer the option to borrow against it. The absence of cash value makes term life generally more affordable than permanent policies.

Understanding Policy Loans

When a life insurance policy has accumulated sufficient cash value, the policyholder can take out a policy loan. This is an advance from the insurer, with the policy’s cash value serving as collateral, not a withdrawal of the cash value itself. The process is typically straightforward, often not requiring a credit check or lengthy application, as the loan is secured by the policy’s value.

Interest accrues on the outstanding loan balance. Interest rates typically range from 5% to 8%, which can be competitive compared to personal loans or credit cards. While there is no mandatory repayment schedule for a policy loan, repayment is generally advisable. Policyholders can repay the loan and interest via a lump sum or periodic payments, or allow interest to accrue.

An outstanding loan and any accrued interest will reduce the death benefit paid to beneficiaries if the insured passes away before repayment. If the loan balance, including interest, grows to exceed the policy’s cash value, the policy could lapse. This can lead to loss of coverage and potential tax consequences, as any borrowed amount exceeding premiums paid could become taxable income. Insurers typically provide a 30-day notice before a policy lapses due to an outstanding loan.

Policy loans are generally not considered taxable income if the policy remains in force and the loan amount does not exceed premiums paid. However, if the policy lapses or is surrendered with an outstanding loan, the amount exceeding premiums paid (the cost basis) may become taxable. Interest paid on a policy loan is typically not tax-deductible.

Key Differences in Policy Loan Features

While both whole life and universal life policies allow for loans, specific features related to these loans can differ. These distinctions often stem from how each policy’s cash value grows and its overall design.

Interest rates on policy loans can vary. Whole life policies often feature fixed interest rates for their loans, offering predictable repayment costs. Universal life policies, however, may have variable loan interest rates, which can fluctuate based on market conditions or the insurer’s set rates. This difference in rate structure impacts the long-term cost and predictability of borrowing.

The underlying growth mechanism of the cash value also influences loan features. Whole life insurance guarantees a specific rate of cash value growth, meaning the collateral for the loan is stable and predictable. In contrast, the cash value growth in universal life policies can be more dynamic, tied to interest rates or market indexes, which may introduce variability to the collateral’s value over time. This variability could affect the policy’s performance with an outstanding loan, particularly if market performance is poor.

Accessing loans can also have differing impacts. For whole life policies, the cash value used as collateral continues to earn its guaranteed interest and potential dividends even while a loan is outstanding, though some insurers may adjust dividend payments on the portion of cash value securing a loan. With universal life, the flexibility in premium payments and death benefit adjustments means policyholders might have more levers to manage their policy while a loan is active, potentially adjusting payments to prevent a lapse if the loan grows too large. However, for both, an unpaid loan reduces the death benefit, and if the loan exceeds the cash value, the policy could terminate.