Borrowing Money: Government Mutual Life Insurance Options

Borrowing money from a government mutual life insurance policy is a convenient way to get quick access to cash. However, it is important to understand the risks and requirements involved. Firstly, only permanent life insurance policies that have accumulated a cash value, such as whole life or universal life insurance, can be borrowed against. Term life insurance policies, which are cheaper and more common, do not have a cash value component and therefore cannot be used as collateral for a loan. For permanent life insurance policies, the cash value grows over time, and once it reaches a sufficient amount, typically after several years, it can be used as collateral. The loan process is straightforward, and there are no lending requirements, credit checks, or restrictions on how the funds are used. However, failure to repay the loan, including the interest, can result in a reduced death benefit for your loved ones and even cause your policy to lapse, leading to tax implications.

Borrowing against permanent life insurance

Permanent life insurance is designed to be a safety net that provides money to loved ones when you pass away. However, permanent life insurance also offers additional benefits. Over time, this type of life insurance accumulates cash value, which makes your policy a flexible financial tool.

As the years pass, the cash value can be a source of funding for emergencies or opportunities. One common way to make use of that cash value is to borrow against it. This can help with things like emergency expenses, college costs, or even making it through down markets in retirement.

A policy loan gives you quick access to cash. You simply fill out a form, and then the insurance company sends you the money within a couple of days. Life insurance loans typically don't affect your credit because your policy is the collateral for the loan, and there's no set repayment schedule. There's no loan approval process, which means your credit score is unaffected when you get the loan.

Repaying the loan

Repaying a policy loan is also easy and flexible. Unlike most traditional loans, a policy loan doesn't have a fixed repayment schedule. If you want to make a large payment one month, you can. If you want to pay nothing the next month, you can. But it's worth noting that your loan will accumulate interest. That means that if you don't make payments, the balance will increase over time.

If you have a loan against your policy when you die, the death benefit will be reduced by the amount of the loan. And if the loan balance gets too high, the insurance company will surrender or "lapse" your policy to pay the loan, which can result in a negative tax consequence. Once you repay your loan, the full benefits of the policy will be restored.

Different policies come with different rules, but you can typically borrow against most of your cash value. However, if your loan amount gets too high, it's possible that the insurance company will surrender your policy to pay off the loan. Depending on your situation, you could then owe tax.

As soon as you accumulate sufficient cash value, you can borrow against it. But it could take 10 years or more for your policy to build enough cash value for a loan to be feasible. If you're looking to access funds, you may want to talk through options with a financial advisor.

You can borrow against any policy that accumulates cash value, like whole life or universal life. If you have a term life insurance policy, your policy won't accumulate cash value, and you can't take a loan against it.

The tax implications of borrowing against life insurance

When you sell traditional investments, you owe taxes on any gain. If you surrender a life insurance policy, you'll also owe taxes on the gain (money you made above the basis you paid into your policy—usually the amount you paid in). However, in most cases, you won't owe taxes if you're simply taking a loan against your insurance, as long as your policy stays in place. This can be particularly beneficial in retirement if you're working to manage the taxes you owe in a particular year.

But it's important to work with a financial advisor, as there can also be a negative tax consequence if your loan balance gets too high. If you don't make payments on a policy loan, interest will accrue—and if the interest isn't paid, it will be added to your loan balance, increasing the amount you owe. At some point, if you don't make payments on the principal or interest, the loan balance could become equal to your policy's cash value. Once that's the case, your policy will lapse. At that point, two things will happen. First, the insurance company will surrender your policy. Second, the company will use the cash proceeds from the surrender to pay off the loan balance. In such cases, you most likely won't receive any surrender proceeds from the policy.

Pros and cons of borrowing from permanent life insurance

Borrowing from permanent life insurance can be a quick and easy way to get cash when you need it. However, there are some pros and cons to consider before doing so.

Pros

• It doesn't take long to access your loan funds: There is no approval process, credit check, or income verification. You will usually receive a check within a week.
• You can use the loan funds for whatever you choose: There are no restrictions on how you can spend the money.
• Loans do not have to be paid back: There is no required monthly payment and no payback date.
• Money from an insurance policy loan is not taxed as income: Policy loans are not considered taxable income. You can borrow all your cash value without owing income tax.
• Interest rates are low: Interest rates are much lower than the average rate for personal loans and credit cards, typically ranging from 5% to 8%.
• No credit check required: Since you are borrowing your own money, no formal credit check is needed to qualify for a policy loan.

Cons

• The death benefit will decrease if the loan isn't repaid: If you die before paying back your policy loan, the loan balance plus the interest accrued will be subtracted from the death benefit that would be given to your beneficiaries.
• You will owe interest on the loan: The insurance company will charge you interest on the outstanding balance.
• Failing to repay your loan may result in losing insurance coverage: If the loan balance increases above the amount of the cash value, your policy could lapse and be terminated by the insurance company. You would lose your insurance protection and owe income tax on any amount you received above what you paid in life insurance premiums.
• Minimum cash value required: You need to have sufficient cash value before you can take a loan. This could take several years.
• Borrowing amount limited: You can only borrow up to a certain percentage of your cash value, typically around 90%.

Borrowing against whole life insurance

Firstly, you can only borrow against a permanent life insurance policy, which includes whole life insurance and universal life insurance. These policies are more expensive than term life insurance but have no predetermined expiration date. If sufficient premiums are paid, the policy will remain in force for the lifetime of the insured. While the monthly premiums are higher, money paid into the policy that exceeds the cost of insurance builds a cash value that is part of the policy. This cash value is designed to offset the rising cost of insurance as you age, allowing premiums to remain level throughout life.

The cash value of permanent life insurance policies grows over time and can be used as collateral for a loan. Borrowing against the cash value of your life insurance policy can provide quick access to cash for any reason. To borrow against your policy, you simply fill out a form, and the insurance company will send you the money within a few days. There is no loan approval process, and your credit score is not affected. Additionally, the loan is not recognised as income by the IRS, so it remains tax-free as long as the policy stays active.

However, it is important to note that a policy loan will accumulate interest, and you are expected to pay it back with interest. While there is no mandatory monthly payment, if the loan is not paid back, interest will be added to the balance, and the policy could lapse. In this case, the policy will be surrendered, and you will likely owe taxes on the amount borrowed. It is also important to keep in mind that a policy loan will reduce the death benefit if not paid off.

Each insurance company will have different rules, but generally, you can borrow up to 90% of the cash value of your policy. It is important to carefully consider the pros and cons of borrowing against your life insurance policy and to work with a professional to ensure you have a solid plan to repay the loan.

Borrowing against universal life insurance

Firstly, it's important to understand 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 designed to be in force for the lifetime of the insured and have no predetermined expiration date. While they are more expensive than term life insurance, they accumulate cash value over time, which can be borrowed against. The cash value in these policies is meant to offset the rising cost of insurance as you age, ensuring that premiums remain level throughout your life.

Universal life insurance is a type of permanent life insurance that includes an investment savings component. The cash value portion of a universal life insurance policy can either earn interest or be tied to an investment account or index, allowing the funds to grow over time.

When borrowing against a universal life insurance policy, you are essentially borrowing from yourself, with the policy's cash value serving as collateral. This means that there is no impact on your credit score, no loan approval process, and no set repayment schedule. Additionally, the loan is not recognised as income by the IRS, so it remains tax-free as long as the policy stays active. However, it is important to note that the loan will accumulate interest, and if left unpaid, it could cause the policy to lapse.

Most insurance companies allow you to borrow up to 90% of the policy's cash value. It's important to keep in mind that if you pass away with an outstanding loan, it will reduce the amount of money your beneficiaries will receive. Therefore, it is recommended to work with a professional to ensure you have a solid plan to repay the loan.

Before taking out a loan against your universal life insurance policy, consider the potential risks, such as reducing the death benefit and tampering with the guarantee. It's also crucial to understand the tax implications, as you may owe taxes if the loan is not repaid or if the policy lapses.

Borrowing against variable life insurance

Variable universal life insurance is a type of permanent life insurance that combines insurance with investment options. The cash value of a variable universal life insurance policy is tied to investments, such as the stock market, allowing for potential growth but also carrying the risk of loss. Borrowing against this type of policy can provide several benefits, such as:

• No credit check or approval process: There are no lengthy applications or approvals, and your credit score remains unaffected.
• Flexible repayment: There is no fixed repayment schedule, and you can choose to pay back the loan at your own pace.
• No restrictions on usage: You can use the money for anything you need, without having to justify your spending.
• Low-interest rates: Interest rates on life insurance loans are typically lower than those for personal loans or credit cards.

However, there are also several risks and disadvantages to consider:

• Reduced death benefit: If the loan is not repaid before the insured person's death, the loan amount and interest will be deducted from the death benefit, reducing the amount received by beneficiaries.
• Potential tax consequences: If the loan is not repaid, or if the policy lapses, you may owe taxes on the borrowed amount.
• Interest accumulation: Interest accrues on the loan, and if left unpaid, it can cause the loan amount to exceed the policy's cash value, leading to a potential lapse in coverage.
• Slower cash value growth: Taking out a loan may slow down the growth of your cash value over time.
• Rider reductions: Borrowing against the policy may reduce the amount available for special features, such as an accelerated death benefit rider.

Before taking out a loan against your variable life insurance policy, it is important to weigh the pros and cons carefully. Consult with a financial advisor or professional to ensure you understand all the implications and create a solid plan for repayment.

Frequently asked questions