Life Insurance Preferred Loans: What You Need To Know

Life insurance policy loans are a convenient way to access the cash value of your policy. They are a no-questions-asked way to borrow cash for a variety of purposes, without any additional requirements such as a credit check, employment verification, or minimum income requirements. However, borrowing against a life insurance policy isn't risk-free; unpaid loans may reduce the death benefit or even cost you your policy. Preferred loans are a specific provision on cash value life insurance policies, where the interest credited to the policy after a certain number of years is equal to the interest charged on any existing policy loans.

How to get a preferred loan

A preferred loan is a specific provision on cash-value life insurance policies. It allows the policyholder to borrow money from the insurance company, using their life insurance policy's cash value as collateral.

Step 1: Have a permanent life insurance policy

To be eligible for a preferred loan, you must have a permanent life insurance policy, which includes whole life insurance and universal life insurance. These policies have a ""cash value" component that helps build wealth on a tax-deferred basis. This cash value is what you will be borrowing against when taking out a preferred loan.

Step 2: Build up sufficient cash value

It may take several years for your cash value to grow to a meaningful amount before you can borrow against your policy. The time it takes will depend on the structure of your specific policy. Once your policy has accumulated enough cash value, you can use it as collateral to request a loan from your insurance company.

Step 3: Submit a loan request

Contact your insurance company to submit a loan request. There is typically no approval process, credit check, or employment verification required. You will need to fill out a company-specific request form and provide any other necessary information or documentation.

Step 4: Understand the loan terms and conditions

The amount you can borrow will depend on the terms and conditions of your policy and can usually be up to 90-95% of the policy's cash value. The interest rate on the loan will also depend on the type of policy you have. It could be a fixed or variable rate. Make sure you understand all the terms and conditions of the loan before proceeding.

Step 5: Receive the loan

After your loan request has been approved and processed, you will receive the funds, usually within a matter of days.

Step 6: Repay the loan (optional)

Repayment of the loan is not required. However, if you choose to repay it, you can do so on a schedule that works best for you. Keep in mind that if you don't repay the loan, the death benefit of your policy will be reduced by the amount of the loan and any accrued interest. Also, if the loan balance plus interest exceeds the cash value of your policy, your coverage may be at risk.

Advantages of preferred loans

Preferred loans are a specific provision on cash value life insurance policies. They are a type of loan that uses the cash value of a permanent life insurance policy as collateral. This allows the policyholder to borrow money from the insurance company using the value of their policy as security.

• No credit check or approval process: There are generally no additional requirements, such as a credit check, employment verification, or minimum income requirements, making it easy to access the cash.
• Quick access to funds: The process of obtaining a preferred loan is relatively simple and quick, providing fast access to funds when needed.
• Flexible repayment terms: There is no required monthly payment or payback date, and repayment can be made at the borrower's convenience.
• Competitive interest rates: Interest rates for life insurance loans are typically lower than those for personal loans or credit cards, making them a more affordable option.
• No impact on credit score: Preferred loans do not affect the borrower's credit score, as they are not reported to credit bureaus.
• Tax advantages: The interest paid on preferred loans may be tax-deductible, and the loan itself is generally not considered taxable income.
• Privacy: Borrowing against a life insurance policy is a private transaction between the policyholder and the insurance company.
• No collateral required: The life insurance policy itself acts as collateral for the loan, so there is no need to put other assets at risk.
• Potential for loan forgiveness: If the policyholder passes away with an outstanding loan, the loan amount is typically deducted from the death benefit, effectively forgiving the debt.
• Builds cash value: The cash value of the policy can continue to grow even while there is an outstanding loan, allowing the policyholder to build their wealth over time.

Drawbacks of preferred loans

Preferred loans are a specific provision on cash value life insurance policies. They allow the policyholder to borrow money from the insurance company, using their life insurance policy's cash value and death benefit as collateral. While preferred loans can be a convenient way to access cash quickly, there are several drawbacks to consider:

Unpaid loan balances reduce the death benefit

If the policyholder passes away before the loan is repaid in full, the benefit payout to their beneficiaries will be reduced by the amount still owed, including any accrued interest. This could be problematic if the intended benefit amount is needed by the beneficiaries.

Coverage may lapse

If the loan is not repaid promptly, the loan balance, plus interest, may exceed the cash value of the policy. In this case, the insurance company can terminate the policy, resulting in a loss of insurance coverage for the policyholder.

Tax consequences

If the loan is not repaid and/or the policy lapses, the policyholder or their beneficiaries may owe income taxes on the amount borrowed. There may also be other tax consequences, so it is essential to discuss these potential implications with a financial or tax professional before taking out a preferred loan.

Complexity

The interplay of factors in a preferred loan can be complex. The assumptions used in the loan and market conditions can work in the policyholder's favour, but they can also put the policy at risk of being underwater without their knowledge.

Impact on policy dividends

Policy dividends may change over time, affecting the amount of money in the policy that is eligible to be borrowed.

Repaying a preferred loan

A preferred loan is a specific provision on cash value life insurance policies. The interest charged on any existing policy loans is matched by an equal amount of interest credited to the policy after a certain number of years.

The ease of repayment and the absence of a strict schedule are notable advantages of preferred loans. However, it is crucial to monitor the loan balance regularly to ensure the loan is operating as expected and to prevent the policy from lapsing. While the funds borrowed through a preferred loan are typically not taxable, there may be tax implications if the policy lapses or is terminated before the loan is repaid. In such cases, the outstanding loan amount is considered a withdrawal, and you may owe income tax on the cash value received beyond the premiums paid.

To summarise, preferred loans offer flexibility in repayment options, but it is essential to stay vigilant about the loan balance and potential tax consequences to ensure the loan does not compromise the financial security provided by the life insurance policy.

Preferred loans vs. term life insurance

Life insurance is a financial safety net for your loved ones in the event of your death. It is a way to ensure that your family has the financial support they need after your passing. There are two main types of life insurance: term life insurance and permanent life insurance, which includes whole life and universal life insurance. While term life insurance provides coverage for a specified period, permanent life insurance offers lifelong protection and also builds cash value over time. This cash value can be borrowed against through a preferred loan.

Preferred loans are a type of loan specifically associated with permanent life insurance policies. They allow policyholders to borrow against the cash value of their life insurance policy. The key feature of a preferred loan is that the interest charged on the loan is equal to the interest credited to the policy after a certain number of years. This means that the interest rate on the loan is effectively offset by the interest earned on the policy, resulting in a net-zero cost for the borrower.

One of the main advantages of preferred loans is the ease of access to cash. There is no approval process, credit check, or strict repayment schedule associated with these loans. Policyholders can borrow up to a certain percentage of their policy's cash value, typically up to 90% to 95%. However, it is important to note that unpaid loans may reduce the death benefit or even cost the policyholder their entire policy.

In contrast, term life insurance does not typically accumulate cash value. As a result, policyholders cannot borrow against the value of their term life insurance policy. Term life insurance premiums are subject to medical underwriting, meaning that younger and healthier individuals will generally pay lower rates. On the other hand, permanent life insurance premiums are typically higher due to the cash value component and are not as heavily influenced by age and health status.

When deciding between term life insurance and permanent life insurance with the option of a preferred loan, it is important to consider your financial goals and needs. Term life insurance may be more suitable for those who want straightforward coverage for a specific period, such as during their working years or until their children become financially independent. On the other hand, permanent life insurance with the potential for preferred loans may be more appropriate for those seeking lifelong coverage and additional financial flexibility.

Frequently asked questions