What Types of Life Insurance Can I Borrow From?

Life insurance primarily serves as a financial safeguard, providing a death benefit to designated beneficiaries. Beyond this fundamental protection, certain types of policies can also act as a personal financial resource during the policyholder’s lifetime. These specific policies build an accumulated value that can be accessed, offering a flexible option for various financial needs. Understanding which policies offer this feature and how it operates is important for leveraging life insurance beyond its protective role.

Policies That Allow Borrowing

The ability to borrow from a life insurance policy hinges on the presence of a “cash value” component. This cash value is a savings element that accumulates within certain permanent life insurance policies over time. It grows on a tax-deferred basis, and a portion of each premium payment contributes to its accumulation, distinct from the amount allocated to cover the cost of insurance. The cash value serves as the collateral for any loans taken against the policy.

Term life insurance, designed to provide coverage for a specific period, does not build cash value. In contrast, permanent life insurance policies remain in force for the policyholder’s entire life, provided premiums are paid, and they are the types that accumulate cash value and allow borrowing.

Whole life insurance is a type of permanent policy characterized by fixed premiums, guaranteed cash value growth, and a guaranteed death benefit. The cash value in a whole life policy grows at a predetermined rate, offering predictable access to funds. Universal life insurance provides more flexibility, allowing adjustments to premium payments and the death benefit. Its cash value growth can vary, often linked to an interest rate set by the insurer. Variable universal life insurance further introduces investment risk by allowing the cash value to be allocated into sub-accounts, similar to mutual funds. While offering potential for higher returns, it also carries higher risk.

How Policy Loans Function

A life insurance policy loan differs significantly from traditional bank loans because it is not extended by a third-party lender. Instead, it is an advance against the policy’s own cash value, with the cash value itself serving as collateral. This unique structure means that eligibility for a policy loan does not involve a credit check or a lengthy application process, as the loan is secured by an asset already owned by the policyholder.

These loans are interest-bearing, with the interest rate set by the insurance company, often within a competitive range, such as 5% to 8%. The interest accrues on the outstanding loan balance, and this accrued interest can either be paid periodically or added to the loan principal. Repayment terms are flexible; policyholders are not required to adhere to a fixed repayment schedule, or even to repay the loan at all.

Any outstanding loan balance, including accrued interest, will directly reduce the death benefit paid to beneficiaries upon the policyholder’s passing. For example, if a policy has a $500,000 death benefit and an outstanding loan of $50,000, the beneficiaries would receive $450,000. As long as the policy remains in force, the loan proceeds are not considered taxable income by the Internal Revenue Service (IRS).

Important Considerations Before Borrowing

Borrowing against a life insurance policy carries specific implications. This reduction can be substantial if the loan remains unpaid for an extended period.

A significant risk involves the potential for the policy to lapse. If the accumulated loan balance, including interest, exceeds the policy’s cash value, the policy could terminate. Such a lapse can have serious tax implications, as the loan amount that exceeds the premiums paid into the policy may be considered taxable income by the IRS. Maintaining sufficient cash value to cover the loan and its accruing interest is therefore important.

Taking a loan also means that the portion of the cash value used as collateral is no longer participating in the policy’s growth. This can slow the overall accumulation of the policy’s cash value, affecting its long-term financial performance. Policyholders initiate a loan by contacting their insurer and completing necessary forms, with funds often disbursed within a few business days.

While repayment is flexible, consistent interest accrual means the loan amount grows if not paid down, further impacting the death benefit and increasing lapse risk. Other ways to access cash value include withdrawals, which permanently reduce the cash value and death benefit, or partial surrenders. Unlike loans, withdrawals can be taxable if they exceed the premiums paid into the policy.