Borrowing Money From Supplemental Life Insurance: Is It Possible?

Borrowing money from a life insurance policy is possible, but only if the policy has a cash value component. This is known as a life insurance loan, and it's important to understand the pros and cons before taking one out. Life insurance loans can be a quick and easy way to access cash, and they typically don't require a credit check or affect your credit score. The money can be used for anything, and there's no formal repayment timeline. However, if the loan isn't repaid before the policyholder's death, it will reduce the death benefit that their beneficiaries receive. Interest on the loan can also accumulate and cause the policy to lapse, resulting in a loss of coverage and potential tax penalties. It's crucial to carefully consider the advantages and disadvantages of life insurance loans before making a decision.

Borrowing from a life insurance policy

Life insurance is often thought of as a safety net for your loved ones after you're gone, but did you know that certain types of life insurance can provide financial benefits while you're still alive? Borrowing against your life insurance policy allows you to access funds when you need them, tapping into the cash value that builds up over time. It can be an appealing option when you want to avoid taking on traditional loans or dipping into your savings.

However, it's important to remember that borrowing from your life insurance policy isn't without risks. If you don't pay back the loan, it will be deducted from your death benefit, reducing the amount your beneficiaries receive. Additionally, if the cash value dips too low and the loan remains unpaid, your policy could lapse, leaving you without coverage and potentially facing tax penalties.

With that in mind, let's explore the process of borrowing from a life insurance policy, including the advantages and disadvantages, to help you make an informed decision.

Advantages of Borrowing from a Life Insurance Policy

Borrowing against your life insurance policy offers several unique benefits:

• No red tape: There are no long applications or approvals required. If your policy has enough cash value, you simply request the loan and access the funds within a few business days.
• Flexibility: You can use the money however you like, without justifying your spending to anyone.
• Privacy: Life insurance loans are not reported to credit agencies or the government, so they won't affect your credit score.
• Repayment flexibility: There is no pressure to pay back the loan right away. You can choose to only pay the interest so that the loan doesn't eat into your cash value.
• No risk to assets: If you don't repay the loan, the worst that happens is a reduced death benefit. Your home, car, or other assets are not at risk.

Disadvantages of Borrowing from a Life Insurance Policy

Despite the advantages, there are some serious disadvantages to consider before borrowing from your life insurance policy:

• Interest accumulation: Interest accumulates over time, and if left unchecked, it could drain your policy's cash value.
• Slowed cash value growth: Borrowing from your policy may slow down the growth of your cash value, as the amount credited or dividends may be reduced.
• Shrinking death benefit: The longer the loan remains unpaid, the more it chips away at the death benefit your beneficiaries will receive.
• Rider reductions: Borrowing from your policy may reduce the amount available for special features, such as an accelerated death benefit rider.

How to Borrow from a Life Insurance Policy

The process of taking out a loan from your life insurance policy is straightforward. You'll need to contact your agent or insurance company and fill out a basic form. If your cash value is sufficient, you'll receive the funds within a few business days. Remember, just because the cash is accessible doesn't mean it's free money. Borrowing from your policy can have long-term effects, so it's important to weigh your options carefully.

In summary, while borrowing from a life insurance policy can provide financial flexibility, it's crucial to understand the potential risks and disadvantages. Make sure you consider the long-term impact on your coverage and the potential reduction in the death benefit for your beneficiaries.

Pros and cons of borrowing from a life insurance policy

Borrowing from a life insurance policy can be a quick and easy way to get cash in hand when you need it. However, it is important to consider the pros and cons before making a decision.

Pros of Borrowing from a Life Insurance Policy:

• No credit check required: Since you are borrowing against your own policy, there is usually no formal credit check or approval process involved.
• Low-interest rates: Life insurance policy loans typically have lower interest rates compared to bank loans or credit cards, ranging from 0% to 2% or 5% to 8%, depending on the source.
• Flexible repayment: There is no set repayment timeline, allowing you to pay back the loan at your own pace.
• No impact on credit score: Policy loans do not affect your credit score as they are not reported to credit bureaus.
• Quick access to funds: The process of obtaining a loan from your life insurance policy is generally faster and more straightforward than a traditional bank loan.
• No restrictions on usage: You can use the loan for anything you choose, such as household bills, education, or emergencies.
• Tax advantages: Policy loans are generally not considered taxable income, and the interest paid is usually tax-deductible.

Cons of Borrowing from a Life Insurance Policy:

• Reduced death benefit: If the loan is not repaid before the policyholder's death, the outstanding loan balance, including any accrued interest, will be deducted from the death benefit paid to the beneficiaries.
• Risk of losing coverage: If the loan balance exceeds the policy's cash value, the policy may lapse, and you could lose your insurance coverage.
• Interest accrual: Interest continues to accrue on the outstanding loan balance, increasing the total amount owed over time.
• Limited borrowing amount: You can typically only borrow up to a certain percentage (usually around 90%) of the policy's cash value, which may not be sufficient for your needs.
• Tax implications: If the policy lapses or is surrendered before the loan is fully repaid, there may be tax consequences, and you could owe income tax on the amount borrowed.

Types of life insurance you can borrow from

Borrowing money from your life insurance policy can be a quick and easy way to get cash. However, it is important to note that you can only borrow against your policy if it has a cash value component. This type of policy is known as permanent life insurance, which includes whole life insurance and universal life insurance. These policies are designed to provide coverage for your entire lifetime and do not have a predetermined expiration date.

Whole Life Insurance

Whole life insurance is a type of permanent life insurance that offers lifelong coverage and builds cash value over time. A portion of each premium payment goes towards building a cash value, which operates as a tax-deferred savings or investment account. Once the cash value reaches a certain threshold, you can borrow or withdraw from that account. It is important to note that it may take several years for your policy to accumulate enough value to borrow against.

Universal Life Insurance

Universal life insurance is another type of permanent life insurance that offers flexible premiums and death benefits. The cash value of a universal life policy earns interest based on market trends or a minimum interest rate. This allows the cash value to grow over time, providing an opportunity to borrow against the policy.

Variable Life Insurance

Variable life insurance is a type of permanent life insurance where the cash value is tied to investment options, offering the potential for faster growth. However, it is generally considered riskier compared to other types of permanent life insurance.

Variable Universal Life Insurance

Variable universal life insurance is similar to variable life insurance in terms of cash value accumulation. It offers flexible premiums and death benefits, making it a viable option to borrow against.

It is important to remember that borrowing against your life insurance policy comes with certain risks, such as a reduced death benefit, the risk of policy lapse, and the accumulation of significant interest. Additionally, term life insurance policies, which are less expensive and designed for a limited period, do not have a cash value component and therefore cannot be borrowed against.

How a life insurance loan works

A life insurance loan is a loan you can take out against the cash value component of a cash value life insurance policy. Unlike a bank loan or credit card, policy loans do not affect your credit score and there is no formal approval process or credit check. This is because you are essentially borrowing from yourself, with the policy's cash value serving as collateral.

The loan is not recognised by the IRS as income, so it remains tax-free as long as the policy stays active (provided it's not a modified endowment contract). However, the insurance company will charge interest on the loan balance, which, if unpaid, can cause the policy to lapse.

The loan amount will reduce your available cash value and death benefit. If you pass away while owing money on a life insurance loan, it will reduce the amount your beneficiaries receive.

There is no set repayment schedule for a life insurance loan, but it's important to pay it back in a timely manner to avoid accruing high interest. If the loan is not paid back before the policyholder's death, the loan amount, plus any interest owed, is subtracted from the amount the beneficiaries are set to receive from the death benefit.

There are two main types of life insurance loans: direct loans and indirect automatic premium loans. With a direct loan, you borrow money from yourself, with the policy's cash value serving as collateral. An automatic premium loan allows the insurer to use your cash value to pay your life insurance premiums if you don't.

Most permanent life insurance policies, including whole life, universal life and variable life, offer the opportunity to borrow money from the cash value. Term life insurance, on the other hand, does not have a cash value component, so there is nothing to borrow.

Life insurance loans pros and cons

Borrowing money from a life insurance policy can be a quick and easy way to get cash in hand when you need it. However, it is important to understand the pros and cons before taking out a life insurance loan.

Pros of borrowing against life insurance

• No credit check is required.
• There is no formal approval process.
• Life insurance loans will not affect your credit.
• There is no required monthly payment, and you can pay it off at your leisure.
• The cash value keeps growing, and you can borrow up to 90% of it.
• The loan is not recognised by the IRS as income and is therefore tax-free.
• You can use the loan funds for whatever you choose.

Cons of borrowing against life insurance

• If you are unable to make monthly loan payments, you may lose your life insurance plan.
• If the loan is not paid back before the policy owner passes away, the beneficiary will only receive a portion of the death benefit.
• If the life insurance policy lapses, you may have to pay taxes on it since the tax structure will change.
• You will owe interest on the loan, which can cause the policy to lapse if left unpaid.

Frequently asked questions