Term Life Insurance: Borrowing Against Your Policy?

Life insurance is often considered a safety net for loved ones after death, 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 needed, using the cash value that builds up over time. However, this option is typically only available with permanent life insurance policies, such as whole or universal life insurance, and not with term life insurance. Term life insurance is cheaper and does not have a cash value component, so there is nothing to borrow against. On the other hand, permanent life insurance policies that accumulate cash value can provide living benefits like the ability to borrow against the cash value and make cash value withdrawals. While borrowing against your life insurance can be convenient and flexible, there are also potential downsides, including reduced death benefits, tax implications, and the risk of policy lapse if the loan isn't repaid.

Whole life insurance

Coverage and Protection

Premium Payments

Cash Value Component

One of the distinguishing features of whole life insurance is its cash value component. This savings element allows the policy to accumulate cash value over time, which can be accessed by the policyholder through loans or withdrawals. The cash value grows in a tax-deferred account at a fixed or variable rate, depending on the policy. This feature provides a living benefit, allowing the policyholder to utilize the funds during their lifetime for various purposes, such as a down payment on a home or supplemental retirement income.

Flexibility and Investment

Riders and Customization

Peace of Mind

Long-Term Planning

Limitations and Considerations

While whole life insurance offers numerous benefits, there are also some limitations to consider. The high cost of premiums is a significant factor, as whole life insurance is significantly more expensive than term life insurance. Additionally, the cash value of whole life policies may grow at a slower rate compared to other types of policies, and there is limited flexibility to adjust the premium or death benefit once the policy is issued.

Universal life insurance

The cash value of a universal life insurance policy earns interest based on the current market or the policy's minimum interest rate, whichever is greater. Policyholders may take out a portion of the cash value in the form of partial withdrawals or loans. Borrowing against the cash value of a universal life insurance policy does not have tax implications, although interest will be charged on the loan amount. However, any unpaid amounts will be taken from the death benefit.

While universal life insurance offers flexibility, there are some risks to consider. If the cash value falls too low and the premiums do not cover the COI, the policy may lapse. Additionally, returns are not guaranteed, as interest rates may drop and affect the cash value. Some withdrawals from the policy may also be subject to taxes.

Variable universal life insurance

VUL is similar to variable life insurance, but it allows you to change your premium payment amount. It also offers increased flexibility and growth potential over other life insurance options. However, you should carefully assess the risks before purchasing it.

Here's how VUL works:

Investment Risk and Cash Value

In a VUL, you pick how to invest your cash value by choosing from a variety of subaccounts. Your interest and future growth depend on the investment performance. If your investments perform well, your cash value will grow more quickly. On the other hand, if your investments do poorly, your cash value will not grow as expected, and you may even lose money.

The growth of the VUL insurance policy's cash value is tax-deferred. Policyholders may access their cash value by taking a withdrawal or borrowing funds. However, if you face significant losses, you may need to make larger premium payments to cover the cost of your life insurance and rebuild your cash value. Otherwise, your policy could lapse, and you would lose insurance protection.

Fees and Charges

In addition to the standard administration and mortality fees, the subaccounts in a VUL deduct management fees ranging from 0.5% to 2%. Because the subaccounts are securities, the life insurance representative must be licensed and registered with the Financial Industry Regulatory Authority (FINRA) to sell a VUL.

Pros and Cons of Variable Universal Life Insurance:

Pros

• Control over cash value investments: You can pick the subaccounts that best fit your risk tolerance and investment objectives.
• High growth potential: If your investments perform well, you can achieve higher returns compared to other types of permanent life insurance.
• Adjustable premium payments: Like traditional universal life insurance, VUL allows you to adjust your premium payments to fit your budget.

Cons

• Risk of cash value losses: Your cash value return is not guaranteed, and you could lose money if your investments perform poorly.
• Possible increase in premiums: If your cash value is insufficient to cover the cost of insurance, you may need to increase your premium payments.
• High fees and charges: VULs can charge higher fees because you're paying for both life insurance and investments.
• Surrender charges: Some VUL policies may include a surrender charge, where you owe a penalty if you cancel within a certain period (e.g., 15 years) after purchasing the policy.

Suitability and Alternatives:

A VUL may be suitable if you want permanent life insurance protection, have a higher risk tolerance for investing, and prefer managing investments yourself. However, it's important to carefully consider the risks and complexities associated with VUL and explore alternative options, such as variable life, universal life, whole life, or term life insurance, based on your financial goals and risk appetite.

Term life insurance policies

When purchasing a term life insurance policy, it is important to note that you will not receive any money back if you outlive the policy or if it is cancelled. Additionally, term life insurance policies cannot be converted into permanent policies, which means there is no opportunity for cash value to build over time. As a result, term life insurance policies are not suitable for individuals seeking to borrow against their life insurance.

While term life insurance policies do not offer the ability to borrow, they can be a more affordable option for those who only require coverage for a specific period. However, it is crucial to carefully consider your long-term needs before choosing a term life insurance policy, as the lack of a cash value component may limit your flexibility in the future.

Permanent life insurance

There are several types of permanent life insurance policies, including whole life insurance, universal life insurance, variable universal life insurance, and indexed universal life insurance. Whole life insurance policies have fixed premiums and build cash value in a secure account. Universal life insurance policies offer more flexibility, as premium payments can be adjusted, but this may negatively impact the cash value of the plan and premiums may increase over time. Variable universal life insurance policies have flexible premiums and a savings component, with the savings portion growing based on the investment methods chosen by the policyholder. Indexed universal life insurance policies have the same basic parts as permanent life insurance policies, but the cash value grows based on a chosen stock market index.

One of the main benefits of permanent life insurance is that it lasts for the policyholder's entire life cycle, whereas term life insurance only lasts for a specific amount of time and is typically less expensive. Permanent life insurance also offers a cash value component and provides retirement planning benefits. The cash value of a permanent life insurance policy can be borrowed against, used to pay premiums, or surrendered for cash to fund retirement.

When considering permanent life insurance, it is important to weigh the pros and cons. Permanent life insurance costs significantly more than term life insurance due to the additional benefits it provides. Additionally, whole life insurance rates tend to be higher than universal life insurance rates. Permanent life insurance policies also require a health exam and may have higher premiums for individuals with pre-existing health conditions.

In summary, permanent life insurance offers lifelong coverage, a cash value component, and various customization options through riders. It is a good option for individuals seeking lifelong coverage and a way to build cash value over time.

Frequently asked questions