Borrowing From Life Insurance: Employer-Provided Policy Options

Life insurance is a common benefit provided by employers, but can you borrow against it? Well, it depends on the type of life insurance policy. Term life insurance, the most common type of insurance provided by employers, does not allow borrowing against it because it has no cash value. However, permanent life insurance policies such as whole life and universal life insurance do build cash value, which means you may be able to borrow against them. This cash value acts as collateral for the loan, and the interest rates are typically lower than those for personal loans or credit cards. Nonetheless, borrowing against life insurance is not without risks. If the loan is not repaid, it will reduce the death benefit, and if the cash value dips too low, the policy could lapse, resulting in a potential tax bill.

Borrowing from permanent life insurance

Types of Policies

Permanent life insurance policies, such as whole life and universal life, are the only types of policies that allow you to borrow against them. Term life insurance, which is cheaper and more common, does not have a cash value component and therefore cannot be borrowed against.

Cash Value

The amount you can borrow depends on the cash value of your policy. You can typically borrow up to 90% of the policy's cash value, but this may take several years to accumulate. The cash value is separate from the death benefit, and borrowing from it will not increase the death benefit.

Application Process

There is no approval process, credit check, or income verification required for a policy loan. As long as your policy has sufficient cash value, you can simply request the loan and receive the funds within a few business days.

Interest and Repayment

Interest rates on policy loans are typically lower than those for personal loans or credit cards. There is no set repayment schedule, but it is in your best interest to repay the loan as soon as possible. If the loan is not repaid, the interest will accumulate, reducing the death benefit and possibly causing the policy to lapse.

Advantages

Borrowing against your life insurance policy offers several advantages over traditional loans. There is no red tape or long approval process, and you can use the money for anything you want without having to justify it. There is also no risk to your assets, as you are borrowing from the value of your policy rather than putting up collateral.

Disadvantages

However, there are also some serious disadvantages to consider. If the loan is not repaid, it will reduce the death benefit for your beneficiaries. Additionally, the interest can accumulate and slow down the growth of your cash value. If the loan amount and interest exceed the total cash value, your policy could lapse, leaving you without coverage and potentially facing tax penalties.

Whole life insurance

The cash value of a whole life insurance policy can be borrowed against. Borrowing from a whole life insurance policy can be a quick and easy way to access cash, without the need for a credit check or approval process. The loan is not recognised by the IRS as income and remains tax-free as long as the policy stays active. However, it is important to note that a policy loan will reduce the death benefit if it is not paid off, and interest is added to the loan balance by the insurance company. If left unpaid, this can cause the policy to lapse, and the policyholder may owe taxes on the borrowed amount.

While borrowing from a whole life insurance policy can provide financial flexibility, there are some potential disadvantages to consider. Taking out a loan against the policy can reduce the death benefit for beneficiaries and tamper with the guarantee of the policy. Additionally, some permanent policies may require higher premiums to maintain the guarantee when cash is withdrawn.

Universal life insurance

It is important to note that if you borrow against your universal life insurance policy, interest will be charged on the loan amount, and any unpaid amounts may reduce the death benefit or be taken from it. Additionally, while there are no tax implications for policyholders who borrow against the cash value, some withdrawals may be taxed. Therefore, it is crucial to carefully manage any loans or withdrawals to avoid tax consequences.

Compared to whole life insurance, universal life insurance offers more flexibility in terms of premiums and death benefits. However, the interest rate for universal life insurance is not guaranteed and can change frequently, whereas whole life insurance premiums are fixed for the life of the policy.

Variable life insurance

There are a lot of varieties among variable life insurance policies. They can be designed and customised for a wide range of financial situations and personal goals. For example, different policies might offer various risk-based investment strategies, the ability to cover two people, and living benefits.

Term life insurance

• Are just starting out in their career and may not have the funds for permanent life insurance.
• Want a degree of financial security for those who depend on them.
• Are looking for a convenient, low-cost option for life insurance.

However, it is important to note that term life insurance through an employer may not provide sufficient coverage, especially for those with financial dependents. In this case, purchasing an additional individual policy may be necessary. Additionally, term life insurance through an employer usually ends when the employee leaves the company, which could result in a gap in coverage.

Frequently asked questions