When Can I Borrow Against My Life Insurance?

A life insurance policy loan allows access to funds from a permanent life insurance policy during your lifetime. Policyholders borrow directly from the insurer, using the policy’s accumulated cash value as collateral. It is a loan against the policy’s cash value, not a direct withdrawal. The cash value remains within the policy, continuing to grow according to its terms.

Eligibility for Policy Loans

Accessing a life insurance policy loan depends on the type of policy held. Only permanent life insurance policies, such as whole life, universal life, variable life, and indexed universal life, accumulate cash value and therefore allow for loans. Term life insurance policies, designed to provide coverage for a specific period without a savings component, do not build cash value and cannot be borrowed against.

Cash value is a portion of premium payments allocated to a savings component, growing tax-deferred. Each premium contributes to the death benefit, insurer costs, and cash value. Cash value accumulation rates vary by policy type; whole life policies often have guaranteed fixed growth, while universal and variable policies may tie growth to interest rates or investment performance. Sufficient cash value must build up before a loan is viable, which can take several years of consistent premium payments, often five to ten years. Insurers allow policyholders to borrow up to a percentage of the accumulated cash value, commonly around 90%.

Understanding Policy Loan Mechanics

A life insurance policy loan operates as a loan from the life insurance company, using the policy’s cash value as collateral. The cash value is not withdrawn but serves as security, remaining in the policy to potentially continue earning interest or investment gains. Policy loans incur interest, which can be either fixed or variable, with rates ranging from 5% to 8%. This interest accrues on the outstanding loan balance and must be managed to prevent the loan from growing too large.

Policy loans are not taxable income if the policy remains in force and the loan balance does not exceed premiums paid. The Internal Revenue Service (IRS) views these funds as debt rather than income. Repayment of the loan principal is flexible, often without a fixed schedule, though interest payments are required to prevent the loan balance from increasing. If interest is not paid, it can be added to the loan balance, further increasing the amount owed.

The Policy Loan Process

Obtaining a life insurance policy loan involves a direct process with the insurer. Policyholders initiate the request by contacting their life insurance company. There is no credit check or extensive approval process, as the policy’s cash value serves as collateral for the loan.

The insurer requires specific information, including the policy number and desired loan amount. Once the request is submitted and approved, the funds are disbursed quickly, within a few days. The loan proceeds can be received via direct deposit or check, depending on the insurer’s options.

Managing an Existing Policy Loan

An outstanding policy loan has direct implications for the policy’s death benefit. If the loan, including any accrued interest, is not fully repaid before the policyholder’s death, the outstanding balance will be deducted from the death benefit paid to beneficiaries. This reduces the amount received by the beneficiaries, which can impact their financial security.

An outstanding policy loan carries the risk of policy lapse. If the accumulated loan balance, including accrued interest, exceeds the policy’s cash value, the policy can lapse. If a policy lapses with an outstanding loan, the loan amount may become taxable income to the extent it exceeds the policyholder’s basis (premiums paid). This can result in an unexpected tax liability, as the IRS may consider the unpaid loan a constructive distribution.

Repayment options include regular payments of principal and interest, paying only annual interest, or allowing interest to accrue and be added to the loan balance. Monitoring the loan balance and making interest payments is advisable to prevent the loan from growing too large and jeopardizing the policy.