Which Life Insurance Can You Borrow From?
Unlock the potential of your life insurance. Understand which policies offer borrowing options, how they work, and what you need to consider for financial flexibility.
Life insurance policies can offer more than just a death benefit; some also serve as a financial resource during the policyholder’s lifetime. This ability to access funds is tied to a savings component within certain policies. Understanding which policies offer this feature and how it operates is important for individuals considering life insurance as a flexible financial tool.
Types of Life Insurance with Cash Value
The ability to borrow from a life insurance policy stems from its “cash value” component, a savings element that grows over time. Only permanent life insurance policies offer this feature, unlike term life which provides coverage for a set period and does not build cash value.
Whole life insurance is a permanent policy with a guaranteed death benefit and fixed premiums. A portion of each premium payment is allocated to the cash value, which grows at a guaranteed interest rate. This predictable growth makes whole life policies a stable option for cash value accumulation.
Universal life (UL) insurance is another permanent policy that builds cash value, offering more flexibility than whole life. Premiums can be adjusted within certain limits, and the cash value grows based on interest rates declared by the insurer, often with a guaranteed minimum rate. Variations like Indexed Universal Life (IUL) link cash value growth to a stock market index, such as the S&P 500, with caps on gains and floors to protect against market downturns. Variable Universal Life (VUL) policies allow the cash value to be invested in subaccounts, similar to mutual funds, providing potential for higher returns but also greater market risk.
How Life Insurance Loans Work
A loan from a life insurance policy’s cash value is not a withdrawal, but a loan against the policy’s value, using the accumulated cash value as collateral. The policy remains active as long as premiums are paid and sufficient cash value remains. Policyholders do not undergo a credit check to obtain these loans, as the policy itself secures the borrowing.
Interest accrues on the outstanding loan balance, and while repayment is not required on a strict schedule, interest continues to accumulate. The interest rate is set by the insurance company and can vary, often ranging from 5% to 8% annually. The loan amount usually cannot exceed 90% of the policy’s current cash value. If the loan, including accrued interest, is not repaid, it will reduce the death benefit paid to beneficiaries upon the policyholder’s passing.
Key Considerations for Policy Loans
Before taking a policy loan, it is important to understand the long-term implications for the policy’s financial health. If the outstanding loan balance, including accrued interest, grows to exceed the policy’s cash value, the policy can lapse. A policy lapse with an outstanding loan can trigger a taxable event, as any amount borrowed that exceeds the premiums paid into the policy may be considered taxable income by the IRS.
An outstanding loan also reduces the amount available to beneficiaries. The death benefit will be decreased by the unpaid loan balance and any accumulated interest. Additionally, policy loans can impact how the policy’s cash value grows or how dividends are credited. The portion of the cash value collateralized by the loan may earn a lower interest rate or receive reduced dividends compared to the unencumbered portion, potentially slowing overall cash value growth.