Life Insurance Policy Loans

Eric Van Haaften Permanent Life Insurance

If you are like most people, you probably think of life insurance as a way to provide for your loved ones in the event of your death.

But what if I told you that life insurance policy loans could also be utilized as a source of short-term funding?

That’s right, borrowing against life insurance can be a great way to get access to quick cash.

This informative article will look at life insurance loans and how they work. We will also discuss the pros and cons of taking a loan against your life insurance policy.

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Can you borrow from a life insurance policy?
How do life insurance loans work?
How to borrow against a life insurance policy?
How to reduce payments on an existing policy loan?

Can You Borrow From Life Insurance?

While most people buy life insurance for the protection of their loved ones, some life insurance policies offer you expanded benefits through life insurance policy loans, paid through the accumulation of cash value.

Term policies, the least inexpensive form of life insurance, generally do not accumulate cash value as they expire at the end of the term.

You need to have a permanent policy that accumulates cash value to borrow against a life insurance policy.

Permanent policies, while more expensive, has the benefit of being true to their name: it is a life insurance policy that is there your entire life.

The extra ‘expense’ goes into building your cash value, which acts as a savings account; this cash value accumulates tax-deferred over time.

A life insurance savings account can be a great way to save for long-term financial goals

Which type of Policies Can I Borrow Against?

Policy loans are different with each insurer, the type of policy you purchase, and the specific terms of your contract.

There are several permanent policies eligible for a life insurance policy loan, including Adjustable Life, Whole Life, Universal Life, Indexed Universal Life, and Variable Life.

How Soon Can I Borrow from My Life Insurance Policy?

Borrowing from your universal or whole life policies can be done when the minimum contracted cash value is achieved.

Life insurance as an asset class grows slowly, and building a substantial cash value in your policy can take many years.

You will need to have accrued cash value to take a loan out against your policy.

When you borrow from the policy, your cash values are utilized as collateral on the loan instead of other investments.

Interest rates on policy loans are usually lower than bank loans because the insurance company understands that it can easily take the collateral if you do not make payments.

Plus, when you borrow against your life insurance policy, the outstanding loan does not interrupt the compounding interest inside your policy.

How much can you borrow against your life insurance policy?

Many life insurance companies will allow you to borrow as much as 90% of the cash value within your policy.

For example, if you have $50,000 in cash value, some universal life, and whole life policies allow you to borrow up to $45,000.

Remember that you will be charged an interest rate on your life insurance loan.

Suppose you borrow too much, and your policy loan continues to accumulate unpaid interest on top of the loan.

In that case, the insurance company may cancel the life insurance policy if the total interest accrued PLUS the loan amount EXCEED the death benefit.

Understanding Life Insurance Loans

Loans against your life insurance policy can be a great way to access quick cash, but it’s essential to understand the pros and cons before taking out a loan.

Before you take a loan out on your permanent life policies cash value, there are some key things to consider before borrowing money.

reduction of your death benefits

If you die with an unpaid policy loan, the insurance company will reduce the death benefit by your loan amount.

If you have a $100,000 face amount and a $30,000 loan on your permanent life policy, your beneficiaries will get $70,000 when you pass away.

life insurance loan interest rates

The insurer will not provide any loan repayment schedule and does not require you to pay the loan balance back.

Insurance companies charge interest on policy loans differently based on your specific life insurance policy’s loan provisions.

Interest in advance is when the insurer assesses interest for the entire year and automatically assumes that the loan is outstanding for the full policy year.
Interest in arrears is usually cheaper because the insurer charges interest at the end of the policy year.
Fixed interest rates are guaranteed, so you will understand in advance what your loan interest will be each year.
Variable interest rates can change yearly and will be shown when loan interest is due on your policy’s annual statement.

Interest will accrue on the loan, and in addition to the original loan amount, all goods will need to be paid before the face value is restored to the original value.

The interest will be compounded. This means you will be charged interest on your unpaid interest, which can make the debt quickly add up.

The insurance company may cancel the policy if the total loan and accrued interest exceed the face amount.

The policy earns interest on the loan balance.

The best part about investing in life insurance is that taking a loan against your policy does not interrupt the compounding interest inside your policy.

Policyholders can increase their cash flow and have greater access to liquid assets with a policy loan.

You can use your cash values at any age for an emergency, an investment opportunity, or income for early retirement.

Taxation of life insurance policy loans

For the IRS, policy loans are non-taxable as long as the loan does not exceed the amount paid in premiums for the policy.

If your policy is surrendered or lapses, the loan is considered taxable income above the amount you have paid into your policy.

Here are some additional tips from Investopedia on the tax implications of having a life insurance policy loan.

We always recommend consulting with your tax professional to find out more and verify if any local or state taxes may impact the loan.

Furthermore, your credit rating is unaffected, even if you do not repay the loan. A permanent life policy effectively allows you to be your own bank, tax-free.

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Borrowing Against Life Insurance

Owning a universal life or whole life policy that accumulates cash values is similar to having an additional savings account.

When it’s time to pay the loan back, you will pay it back to yourself instead of a financial institution.

Plus, when you borrow money against your life insurance policy, you keep earning interest and dividends on the total amount of your policy loan.

Because loans are liquid, they can help with many everyday personal needs and business expenses.

We have implemented different loan strategies for clients, which often relate to their specific needs and age when they need to borrow from the policy.

Younger people can cheaply borrow against their policy to cover major personal expenses if a policy loan is ultimately repaid.

Older policyholders can often strategically borrow against their life insurance policy, knowing that the loan balance will be deducted from the death benefit when they eventually pass away.

Like all financial decisions, there are two sides to every coin!

Yes, you can get a loan taken out on your policy, but it does reduce the death benefit available to your loved ones should you pass before the loan is paid back.

Steps for Taking Out a Policy Loan

Since there is no credit or background check, getting a policy loan is much easier than getting a bank loan.

This simplified approval process makes borrowing from life insurance easy for many people with cash needs such as medical emergencies, bridge loans, and retirement income.

For most insurance companies, taking out a policy loan on your cash-value insurance is as simple as filling out a form and verifying your identification.

The amount of your policy loan, the interest rate, and the loan duration will all impact your total future payments when borrowing against your policy.

Before taking out a policy loan, determine what will happen with your loan based on either repaying the loan or maintaining the loan.

Your insurer will have a life insurance loan calculator to assess these variables and provide a policy loan amortization schedule.

If you develop a severe medical condition utilizing your policy’s accelerated death benefit would be a better option than taking out a policy loan.

This living benefit rider allows you to withdraw from your policy’s death benefit to pay for expenses while you are living.

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Policy Loan Rescue Using A 1035 Exchange

A policy loan rescue can be a great option if you have difficulty making premium and loan payments on your current life insurance policy.

A 1035 exchange transfers the policy’s existing cash value and the policy loan into a better-performing insurance policy.

This can help you avoid lapsing your policy and losing all the money you have invested in it.

A few life insurance companies will keep the loan on your old policy before doing a 1035 exchange.

A modern replacement policy may be less expensive, have limited payments, and have more attractive loan interest rates than policies purchased decades ago.

Remember that when the 1035 exchange is completed, the new policy must assume the exact loan value as the old one.

When a policy with an existing policy loan is transferred into a new one without a loan, the IRS will consider the transaction a partial liquidation and collect income taxes.

We are happy to help you with your life insurance loan questions and determine the best options for your specific needs.