Borrowing Money: Which Life Insurance Policies Allow This?

Borrowing money from a life insurance policy is possible, but it depends on the type of policy you have. Term life insurance, for example, does not allow you to borrow money, whereas permanent life insurance policies, such as whole, universal, and final expense insurance, do. This is because permanent life insurance policies have a cash value component, which is a savings-like account that grows tax-free over time. Borrowing against your life insurance policy can be a convenient way to access funds quickly and easily, but it's important to understand the terms and implications fully before doing so.

Borrowing from permanent life insurance

Permanent life insurance is a type of insurance that provides coverage for the rest of your life. It offers a guaranteed death benefit and builds cash value that can be used for policy loans or accessed in other ways. This type of insurance is more expensive than term life insurance but has no predetermined expiration date. As long as regular premiums are paid, the policy will remain in force for the lifetime of the insured.

Permanent life insurance policies, such as whole life and universal life insurance, can be a source of funds through policy loans. These loans are borrowed against the cash value of the policy, which accumulates over time as a portion of each premium payment is allocated to it. The cash value grows at a rate dependent on the type of policy. For example, in a regular universal life policy, it grows based on current interest rates, while in a variable universal life policy, the cash value is invested in the stock market by the policyholder.

Before deciding to borrow from a permanent life insurance policy, it is crucial to fully understand the terms and implications. Consulting with the insurance provider or a financial professional can help review the policy features, loan conditions, advantages, and limitations. Additionally, requesting an in-force policy illustration from the insurer can provide valuable insights into the potential ramifications of the loan on the policy.

No approval process

Borrowing from a life insurance policy is a straightforward process that does not require a formal approval process. This is because the value of the plan is technically yours, and you are essentially borrowing from yourself. There are no long applications, credit checks, or invasive processes involved. Instead, you simply request the loan, and the funds will be on their way to you in just a few business days.

The only requirement is that you have sufficient cash value in your policy to borrow against. This means that you can only borrow against a permanent life insurance policy, such as whole life or universal life insurance, which has a cash value component. Term life insurance, on the other hand, is a limited-term option that does not have a cash value and, therefore, cannot be borrowed against.

It is important to note that while borrowing from a life insurance policy is convenient and offers flexibility, it is not without risks. If you pass away before repaying the loan, the amount you owe, including any accrued interest, will be deducted from the death benefit, reducing the amount your beneficiaries will receive. Additionally, if the loan amount exceeds the policy's cash value, your policy may lapse, and you may owe taxes on the borrowed amount.

Life insurance loans also have several unique perks. They offer quick and easy access to cash without the red tape associated with traditional loans. There are no minimum income requirements, and you don't need to put up other assets, such as your house or car, as collateral. The interest rates are generally lower than those for personal loans or credit cards, and there is no strict repayment schedule.

Interest rates and tax implications

The loan is not recognised by the IRS as income and remains tax-free as long as the policy remains active and in force. However, if the policy lapses or is surrendered with an outstanding loan, you may have to pay income taxes on the gains made through investments. In this case, the taxable amount equals the amount of the gain realised, which is any amount received from the cash value of the policy minus the net premium cost. The presence of a life insurance loan can distort the outcome if/when a life insurance policy is surrendered or lapses, as the insurance company will require that the loan be repaid from the proceeds of the policy.

It is important to note that the death benefit will be reduced if the loan is not paid off before the insured person's death. The insurance company will subtract the outstanding debt, including any interest owed, from the amount the beneficiaries are set to receive. Thus, it is recommended to monitor the size of the loan compared to the cash value and make interest payments whenever possible to avoid losing your policy and its cash value.

Cash value and death benefits

Permanent life insurance policies, such as whole life or universal life insurance, offer both a death benefit and a cash value component. The death benefit is the amount of money the insurance company pays to your beneficiaries if you die while covered by the policy. The cash value is a savings component that can be accessed during your lifetime.

The death benefit is a tax-free payout to your beneficiaries when you pass away. It is typically shown in the benefits schedule of your policy contract and is often the same as the face value of the policy. The beneficiaries can use the funds they receive from the death benefit however they want.

The cash value is a savings component of a permanent life insurance policy that can accumulate tax-deferred over time. The policy owner can access and use the cash value while they are still alive. The cash value is typically built up over time through premium payments, with a portion of each payment going into the cash value account. The cash value can be used for various purposes, such as paying premiums, taking out a policy loan, or surrendering part of the policy's value for cash. It is important to note that withdrawing from the cash value may reduce the death benefit for your beneficiaries.

The cash value of a life insurance policy can grow in different ways. In a regular universal life policy, it grows based on current interest rates, while in a variable universal life policy, the cash value is invested by the policy owner in the stock market or mutual funds, and its growth depends on the investment performance. It is important to understand the terms and implications of borrowing from the cash value of a life insurance policy, as it may affect the death benefit and the overall financial strategy.

Pros and cons

Borrowing money from your life insurance policy can be a convenient and low-cost way to get quick cash. However, it is important to understand the terms and implications fully before making any decisions. Here are some pros and cons to consider:

Pros:

• No lengthy loan application process: There is no approval process, credit check, or lengthy application process required when borrowing from your life insurance policy. This is because you are essentially borrowing from yourself and the loan is secured by the cash value of your policy.
• Flexible financing: The money can be used for anything, such as bills, vacation expenses, or financial emergencies, without any restrictions or questions from a lender.
• Low-interest rates: Interest rates on policy loans are typically much lower than those of bank loans or credit cards.
• Tax advantages: The loan is not recognized as income by the IRS, so it remains tax-free as long as the policy stays active. Additionally, the cash value continues to grow, even while being used as collateral for the loan.
• No impact on credit score: Unlike traditional loans or credit card debt, policy loans do not appear on your credit report and therefore do not affect your credit score.

Cons:

• Reduced death benefit: Borrowing against your life insurance policy reduces the available cash value and death benefit for your beneficiaries. If you pass away while still owing money on the loan, your beneficiaries will receive a reduced amount.
• Potential for policy lapse: If the loan is not repaid, there is a risk of the policy lapsing. This could result in the loss of insurance coverage and potential tax consequences, as withdrawals from lapsed policies are typically considered taxable income.
• Hidden costs: There may be hidden costs or "opportunity costs" associated with borrowing from your life insurance policy. It is important to understand all the fees and interest charges before proceeding.
• Impact on premium payments: Borrowing against the cash value of your policy may affect your ability to make timely premium payments, potentially leading to a lapse in coverage.
• Replacing borrowed funds: In some cases, you may be required to replace the borrowed funds with after-tax dollars, resulting in double taxation.

Frequently asked questions