Borrow Against Life Insurance

Many people get life insurance to provide funds for their families to spend in the event of a loss of income following death. However, some types of life insurance allow the policyholder to take out a loan against the policy while still living.

Life insurance policy loans have significant advantages over bank loans or credit cards, but they are still loans, and if you do not repay them, there may be penalties.

What is cash value life insurance?

Unlike term life insurance, which pays out only if you die within the policy’s term, permanent life insurance policies, often known as cash value life insurance, pay out regardless of when you die. A portion of your premium is deposited into a separate account, which accumulates cash value.

When there is enough cash value, you can utilize it for:

• Purchase additional coverage to increase the life insurance death benefit.
• Pay premiums if you have a whole life insurance policy, or cover the cost of your coverage and costs if you have a universal life insurance or indexed universal life insurance policy.
• Withdraw cash. If you do not reimburse the money, the death benefit will be reduced.
• Borrow money from your life insurance company. The cash worth is held as collateral. If you borrow against your policy and do not repay it, your insurer will reduce the death benefit amount, just as if you had withdrawn cash.

Getting cash, no questions asked 

Whether you need money to cover a medical bill or your child’s college tuition, a loan against life insurance cash value offers certain advantages over credit cards or personal loans.

Advantages of a life insurance policy loan

No credit check

• If you have enough cash surrender value, you can borrow without answering any questions. It is important to note that accumulating this level of worth might take years, if not decades.
• There is no application process, unlike bank loans. Simply fill out a form to receive money.
• In contrast to credit card debt, cash-value loans are not reported on your credit report.

Low interest rates

Life insurance policy loans are likely to have cheaper interest rates than bank loans or credit cards. According to the Federal Reserve’s November 2022 data:

• The average interest rate on a two-year personal loan is 11.23%.
• The average credit card interest rate is 20.40%.

No timetable for repayment

• You can repay the life insurance loan on your own schedule.
• You are not obligated to return the loan; however, if you do not, the outstanding balance is taken from the policy’s death benefit.

Policy still eligible to earn interest and dividends

While the insurance company will charge you interest on policy loans, you will still earn dividends or interest on the amount borrowed, albeit at a lower rate than on non-borrowed funds.

Disadvantages of a life insurance policy loan

Any technique of obtaining quick cash has drawbacks, and life insurance loans are no exception.

May not be available

It can take years to accumulate significant cash value in a permanent life insurance policy. In the early years of the policy, there may be little or no value to borrow against.

Risk of a decreased payout

If you do not repay the loan within your lifetime, your death benefit will be lowered.

Risk of losing coverage

• Even if the rates are low, life insurance loans require interest payments. And, because interest is frequently deducted from the cash value, it might sneak up on you.
• If your loan plus interest exceeds your policy’s cash value, it may lapse.

Possible tax consequences

If your policy expires before the loan is entirely repaid, you may be liable for income tax on some of the money you haven’t paid. There are some nuances: you will be able to recover your policy’s “cost basis,” which is often the amount of tax-free payments. Anything received above the cost basis is subject to income tax. 

Should you borrow from cash value life insurance?

A loan against life insurance could be a better option than accumulating credit card debt or paying high interest on a personal loan.

Approach any borrowing from your life insurance provider carefully.

• Keep an eye on how much interest is accruing on your loan.
• Set your own repayment schedule for the loan.
• Stick to your loan repayment plan. If you do not intend to return the loan, try taking out a cash withdrawal to avoid paying interest.
• Before taking out a policy loan, get an in-force illustration from your life insurance company. This document will explain how the loan will affect your policy’s future performance. If you take out a policy loan, get an in-force illustration every one to two years to track performance.