Life Insurance: Loan Payable Recording And You

Life insurance loans are a way to borrow money from your own life insurance policy, but only if it has a cash value component. This is usually the case with permanent life insurance policies, such as whole or universal life insurance, rather than term life insurance. Borrowing against your life insurance policy can be a quick and easy way to get cash, without the need for a credit check or approval process. However, it's important to remember that if the loan is not repaid, it will reduce the death benefit and may even cause the policy to lapse, resulting in a potential tax bill.

Borrowing from a life insurance policy

Firstly, it's important to note that you can only borrow against a permanent life insurance policy, such as a whole life insurance or universal life insurance policy. These policies are more expensive than term life insurance but have no predetermined expiration date. If sufficient premiums are paid, the policy is in force for the lifetime of the insured. While the monthly premiums are higher than term, money paid into the policy that exceeds the cost of insurance builds in a cash value account that's part of the policy. This cash value can be used as collateral to take out a loan.

The loan process for borrowing from a life insurance policy is straightforward. There is no approval process or credit check, and you can request a loan from your life insurance company for any reason. The only requirement is that you have sufficient cash value to borrow against, and the minimum amount required varies by insurer. It's important to note that borrowing against a life insurance policy is not risk-free. If you die without paying back your loan, your insurer will deduct the amount owed, including any interest, from your death benefit. Additionally, unpaid loans can cause your policy to lapse, and you may owe taxes on the amount borrowed.

Interest rates for life insurance loans are generally lower than those for personal loans and credit cards, typically ranging from 5% to 8%. However, it's important to pay back the loan in a timely manner, as interest accrues over time. There is no mandatory monthly payment, but you should continue paying your premium on time to avoid a lapse in life insurance coverage.

Before borrowing from a life insurance policy, it's essential to consider the potential risks. Taking out a loan can reduce the death benefit, tamper with permanent insurance guarantees, and result in higher premium payments. Be sure to consult with a financial advisor or estate planning attorney to understand the tax implications and potential impacts on your beneficiaries.

Repaying a loan

There are three ways to repay a life insurance loan:

• Periodic payments of principal with annual payments of interest.
• Paying annual interest only.
• Deducting interest from the cash value.

If you repay the loan with cash, the policy account value and death benefit will increase by the amount of the repayment. However, if the loan repayment amount is greater than the policy cost/tax basis, then this may trigger a taxable event.

If the loan is not repaid before the insured person's death, the loan amount, plus any interest owed, will be subtracted from the death benefit that the beneficiaries receive. This could significantly impact the beneficiaries' payout. Therefore, it is essential to thoroughly consider the pros and cons of a life insurance policy loan before taking one out.

Consulting a financial advisor before taking out a loan against your life insurance policy is recommended to weigh the advantages and disadvantages in the context of your specific situation.

Interest on a life insurance loan

However, if you don't pay back the interest on the loan, the insurance company will reduce the death benefit. The accumulated interest can also reduce the benefit. Therefore, it is important to pay back the loan in a timely manner and make regular payments to avoid accruing significant interest.

If you are unable to pay back the loan before the insured person's death, the loan amount and any interest owed will be subtracted from the death benefit, which could significantly impact the beneficiaries. Additionally, if the policy lapses during the repayment period, you may owe income tax on the amount borrowed.

To avoid these potential issues, consider setting up automatic payments and making a plan for repayment. It is also important to inform your beneficiaries about the loan and repayment plan so they know what to expect.

Death benefits

• Death Benefit Reduction: If you have an outstanding loan on your life insurance policy at the time of your death, the loan amount, including any accrued interest, will be deducted from the death benefit paid out to your beneficiaries. This means that your beneficiaries will receive a reduced payout compared to the original death benefit amount.
• Timely Repayment: To avoid reducing the death benefit, it is crucial to make timely repayments on your loan. Interest accrues on the loan balance over time, and if left unpaid, it can lead to a significant reduction in the death benefit.
• Policy Lapse: In the event that the loan balance, including interest, exceeds the cash value of your policy, your coverage may lapse. This means that your policy will no longer be in effect, and your beneficiaries will not receive any death benefit.
• Tax Implications: If your policy lapses due to an unpaid loan, the amount of cash you borrowed may be treated as income by the IRS, resulting in potential tax liabilities.
• Impact on Beneficiaries: Taking out a loan on your life insurance policy can have a direct impact on the financial security of your beneficiaries. The reduction in the death benefit may affect their ability to cover expenses, maintain their standard of living, or fulfil other financial goals.
• Weighing Options: Before taking out a loan on your life insurance, carefully consider the potential impact on the death benefit and your beneficiaries. Explore alternative sources of funding, such as personal savings or low-interest loans, which may be less risky.

Whole life insurance policies

Whole life insurance is a type of permanent life insurance that combines life insurance with an investment component. It offers a tax-deferred savings benefit if premiums are paid. Whole life insurance policies are more expensive than term life insurance, but they have no predetermined expiration date. As long as sufficient premiums are paid, the policy remains in force for the lifetime of the insured.

The monthly premiums for whole life insurance are higher than those for term life insurance. However, the money paid into the policy that exceeds the cost of insurance builds up a cash value account that is part of the policy. This cash value is meant to offset the rising cost of insurance as the insured person ages, allowing premiums to remain level throughout their life.

The maximum amount that can be borrowed against a whole life insurance policy is usually up to 90% of its cash value. It is important to continue paying premiums on time to avoid a lapse in life insurance coverage. Additionally, if the loan is not paid back before the insured person's death, the loan amount and any interest owed will be subtracted from the death benefit paid to the beneficiaries.

Frequently asked questions