Life Insurance Loans: Borrowing Against Your Policy

Life insurance loans are a way to borrow money using the cash value of your policy as collateral. This means that if you have a permanent life insurance policy, such as whole life or universal life, you can borrow against the cash value that has built up over time. This can be a quick and easy way to access cash, especially if you need money fast for an emergency expense. There is no approval process or credit check required, and the funds can be used for any purpose. However, it's important to consider the downsides as well. If you don't repay the loan before you die, the death benefit for your beneficiaries will be reduced. Additionally, if the loan balance gets too high, your policy could lapse and you may owe taxes on the outstanding balance.

Permanent life insurance policies

You can take a life insurance loan using the cash surrender value of the policy as collateral. The key things to know about life insurance loans are:

• A life insurance loan provides access to the cash surrender value of your permanent life insurance policy.
• Your policy needs to have sufficient cash surrender value before you can take a loan.
• You are borrowing against your policy, not taking money out of it.
• A life insurance loan may be more affordable than other types of loans, such as car loans or racking up credit card debt.
• There is no approval process for a life insurance loan.
• A life insurance loan reduces the policy's cash surrender value and death benefit until it is fully paid back.
• The loan is not taxable as long as the policy stays in force. There could be tax ramifications if the policy lapses or you surrender the policy.

The amount of cash value you can take out of your whole life insurance policy depends on the rules of the insurance company that holds your policy. Usually, if there is accumulated cash value in your policy, you can borrow from it, make withdrawals, or surrender your policy and remove your cash.

The funds from a life insurance loan can be used for any purpose, such as paying for a new furnace, medical bills, or emergency costs. The loan process is relatively simple, and there is no approval process as long as you have sufficient cash value in your policy. The money can be accessed quickly, usually within a couple of days, and there is no credit check required.

However, it's important to note that unpaid life insurance loans may reduce the death benefit or cost you your policy. Therefore, it is recommended to consult a financial advisor before taking out a life insurance loan to weigh the pros and cons.

Borrowing against your life insurance

Life insurance loans are only available on permanent life insurance policies, such as whole life and universal life, that have a cash value component. Term life insurance policies, on the other hand, do not have a cash value and therefore cannot be borrowed against.

With a life insurance loan, you are borrowing against your own assets, so there is no approval process or credit check required. This means you can access funds quickly and easily, usually within a couple of days. The funds can be used for any purpose, and there is no fixed repayment schedule. However, it's important to note that the loan will accumulate interest, and if it is not repaid, it will reduce the death benefit for your beneficiaries.

The amount you can borrow is typically limited to a certain percentage of the cash value of your policy, usually up to 90%. The specific rules and requirements vary by insurer, so it's important to check with your insurance company before making any decisions.

One of the main benefits of borrowing against your life insurance is that the funds are generally not considered taxable income for federal and state taxes. However, if the loan is not repaid and the policy lapses, you may owe taxes on the amount borrowed. Therefore, it's important to work with a financial professional to create a solid plan for repaying the loan.

In summary, borrowing against your life insurance can be a useful tool in certain situations, but it's important to carefully consider the pros and cons before making a decision. It's also essential to work with a financial advisor to ensure that you understand all the implications and that the loan fits into your broader financial plan.

Pros and cons of a life insurance loan

Pros of a Life Insurance Loan:

• Quick access to funds: It doesn't take long to access your loan funds. Getting a life insurance policy loan is quick and easy.
• No approval process: There is no approval process, credit check, or income verification.
• Low-interest rates: Policy loans generally have a much lower interest rate than bank loans.
• No tax: In most cases, the loans are also tax-free.
• No repayment necessary: There is no required monthly payment for a policy loan and no payback date.
• No restrictions on usage: You can use the loan for anything from household bills to a vacation.
• No impact on credit score: Life insurance loans are not reported to credit bureaus, so they won't impact your credit score.

Cons of a Life Insurance Loan:

• Reduced death benefit: If the loan isn't repaid, the outstanding balance will reduce the death benefit your beneficiaries receive.
• Interest accrual: Interest on the loan accrues and can compound, increasing the loan balance over time if left unpaid.
• Risk of losing insurance coverage: If the loan balance increases above the amount of the cash value, your policy could lapse and be terminated.
• Potential tax liability: If your policy lapses and the loan balance exceeds the cost basis, you may face an income tax bill.

Repaying a life insurance loan

Understanding Life Insurance Loans

Before delving into repayment, it's essential to grasp the nature of life insurance loans. These loans are available to individuals who have a permanent life insurance policy with a cash value component. The cash value of the policy serves as collateral for the loan. Life insurance loans offer quick access to funds without the need for a credit check or approval process, making them attractive for emergency expenses. However, it's important to weigh the pros and cons before taking out such a loan.

Repayment Options

Life insurance loans typically don't have a strict repayment schedule or a set timeline for repayment. You have the option to repay the loan in full or make partial payments over time. The interest rate on the loan will depend on your policy, and it can be either fixed or variable. The interest accrues daily and is charged at the policy anniversary, and you will receive a bill for the interest amount.

Benefits of Repaying the Loan

Repaying the loan, especially the interest portion, is in your best interest. By making regular payments, you can prevent the loan amount from increasing due to accrued interest. Additionally, if the loan amount grows beyond the cash value of your policy, your policy may lapse, leading to potential tax consequences. Repaying the loan helps maintain the value of your policy and ensures that your beneficiaries receive the intended death benefit.

Methods of Repayment

You can repay the loan at any time using a mobile app, online customer portal, or by sending in a payment. It's important to clearly mark payments as loan repayments to distinguish them from premium payments. Consult your insurance provider for specific instructions on how to initiate repayments through their platform.

Consulting a Financial Advisor

Before making decisions about repaying your life insurance loan, it's always recommended to seek advice from a qualified financial advisor. They can help you understand how the loan fits into your overall financial plan and guide you in making informed choices about repayment.

Tax implications of a life insurance loan

Borrowing against a life insurance policy is generally tax-free. However, if you don't repay the loan or your policy lapses, you may owe taxes on the amount borrowed.

The money you borrow from a life insurance policy is not considered taxable income, as long as it is equal to or less than the sum of the insurance premiums you have paid. However, if you don't repay the loan, the interest will continue to accrue, which could put your policy at risk of lapsing. If your policy lapses or is surrendered, you will likely owe taxes on any gains made through investments, and your outstanding loan will be deducted from your payout.

In the case of a lapsed policy, the taxable amount equals the amount of the gain realised, which is any amount received from the cash value of your policy minus the net premium cost or the total of premiums paid minus distributions received. This is essentially the gains on your investments. For example, if you've paid $40,000 in premiums and the cash value of your policy is $55,000, you would have realised a gain of $15,000 ($55,000 - $40,000). This gain would be subject to taxation if you surrendered the policy and took the cash value.

It's important to note that even if you don't surrender your policy and simply allow it to lapse, you may still owe taxes on any gains. This is because, in the eyes of the IRS, a lapsed policy is treated as a surrender, and you will be taxed on any gains in the same way.

To avoid unexpected tax consequences, it is crucial to consult with a financial advisor before borrowing from a life insurance policy. They can help you understand the potential risks and rewards of taking out a life insurance loan and guide you in making decisions that align with your financial goals.

Frequently asked questions