What to know before taking a loan from a life insurance policy

Certain life events can require immediate access to cash, whether it’s an emergency, an unexpected health issue, or a planned expense like a child’s education. Whatever the financial need may be, you may not have money to spare after paying day-to-day expenses. While you can take a loan from a bank or pay with a credit card, borrowing from a life insurance policy may be more effective. Take a look at the life insurance options that can provide this benefit and what you need to know before taking a policy loan.

Can you borrow from life insurance?

Yes, it is possible to borrow from certain types of life insurance policies with a cash value component. This component of a life insurance policy represents funds that accumulate over the policy's term and can be accessed by the policyholder during their lifetime. Typically this option is available if the policy has accrued enough cash value.

What is the cash value of life insurance?

Along with providing a death benefit, certain permanent life insurance policies also offer a cash value feature that can accumulate tax-deferred over time and allow the policyholder to potentially access portions of the money while they are still alive. A portion of each premium payment goes toward the cash value and this amount can earn interest throughout the life of the policy. Not all policies offer this feature, so it can be helpful to review policy details or check with a financial professional to determine eligibility.

Which life insurance can you borrow from?

Permanent life insurance policies like whole or universal life typically offer cash value, making it possible to withdraw money or borrow against for certain financial needs. However, term life insurance policies do not have a cash value component, so those with a term policy typically can’t borrow from their policy.

How to borrow against life insurance

If a policyholder has a permanent life insurance policy and has acquired enough cash value, they may be eligible to request a loan directly from the life insurance provider. Borrowing against life insurance often provides more flexibility than a traditional loan because there is typically no approval process as long as the certain level of cash value has been met. The money taken out is usually tax-free and can be used for any purpose. Work with your life insurance provider to review how much can be borrowed, payback options, and any other loan stipulations.

Pros and cons of life insurance policy loans

In addition to providing financial protection for loved ones, certain life insurance policies can offer greater financial flexibility through policy loans. Whether an insured needs money for an unexpected expense or a long-term goal like supplementing retirement income, having access to funds can be hugely valuable. To determine if borrowing against life insurance makes sense for your situation, it’s important to consider both the pros and cons of taking a policy loan.

Benefits of policy loans

•  No credit check required to access funds
•  Flexibility to use money for any purpose
•  Money borrowed isn’t typically taxable
•  Loans don’t have to be paid back prior to death
•  If choose to pay back a loan, interest rates are usually lower than other types of loans

Limitations of policy loans

• Interest is charged on the outstanding loan balance
• If loans are not repaid, the loan amount, plus any interest, can be subtracted from the death benefit
• If loan balance becomes higher than the cash value amount, the policy could lapse
• If policy lapses with an outstanding loan balance, it may trigger a tax event

Should I pay off my life insurance loan?

Life insurance loans typically don’t have a set repayment schedule like traditional ones. A person can often repay a loan at their own pace, but making regular payments can help prevent potential tax consequences or a policy lapse if the loan balance and interest exceed the policy’s cash value. Remember, an outstanding loan balance can reduce the death benefit available for beneficiaries.

Cash value life insurance can provide a death benefit and a savings component, offering both financial protection and a flexible source of income for personal needs. Before deciding to borrow from a life insurance policy, it’s important to understand the terms and implications fully. Checking with the insurance provider or your financial professional allows you to review the policy features, loan conditions, and advantages and limitations of borrowing from your policy, so you can make informed decisions about accessing funds without disrupting your long-term financial strategy.

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