Thinking about borrowing against the cash value in your life insurance policy? Here are a few things you need to know before and after taking out a policy loan.
What is a policy loan?
A policy loan is a feature that allows you to borrow money against the cash value that has built up within your life insurance policy over time. The loan amount is deducted from the cash value of your policy, and you’ll typically be charged interest on the loan.
While you can take out a policy loan for just about any reason, it’s best to reserve policy loans for unexpected emergencies or for special needs such as educational expenses.
But before taking out a policy loan, consider the following information to help you understand what you should know before and after borrowing against your life insurance policy.
What you need to know about policy loans
When you take out a loan against your life insurance policy, it’s important to understand what can happen if you don’t repay your loan. A policy loan is just like any other type of loan in that until it is repaid, interest will accrue; and if the interest is not paid, it will be added to your loan balance, increasing the amount you owe.
What you need to know is that if you were to die before the loan’s outstanding principal and accrued interest are paid, the amount will be deducted from the death benefit of your life insurance policy. For this reason, be cautious about borrowing too heavily against your policy because you could be jeopardizing the very reason for purchasing insurance in the first place – the security and welfare of your beneficiaries. Furthermore, there are potential tax implications should your policy lapse with an outstanding loan.
Considerations before taking out a policy loan
It’s always a good idea to speak with your financial or insurance professional when considering a policy loan. A professional can better advise you as to the financial impact a policy loan can have on your policy, as well as other options that may be available to you. For example, they can weigh your immediate financial need against the potential future impact of loan interest accumulation and a reduced death benefit. If you do take out a loan, ask to see a policy illustration that can show the current impact of your loan on your policy’s death benefit.
How much can you borrow from your life insurance policy?
The amount you can borrow from your life insurance policy will depend on several factors, including the type of policy you have, the cash value accumulated in the policy, and the terms of the insurance company.
How soon can you borrow against a life insurance policy?
Once the cash value reaches a certain threshold, often after several years, you can usually start borrowing against it. The exact time frame of when you can borrow will vary depending on the type of policy, the premiums paid, and your insurer’s rules.
How to be a responsible borrower
Policy loans do not come with a repayment schedule and are not required to be repaid. This means that you may elect to repay some, all, or none of the loan. However, it’s best to always keep track of your loan and unpaid loan interest accumulation. If you are unable to repay your loan, talk to your financial professional or call your insurance professional to discuss your options.
Frequently asked questions
Can I borrow money from my life insurance to buy a house?
Yes, if your permanent or whole life insurance policy has accumulated enough cash value, you may be able to take out a policy loan to use toward a down payment or other home-related expenses. It’s important to consult with your financial advisor to understand the potential impact of borrowing against your life insurance policy.
Who gets the interest on a life insurance loan?
When you borrow from your life insurance policy, the insurance company will charge you interest on the loan amount. This interest will go to the insurance company. However, while you’re paying interest on the loan, the money you borrowed is still working for you, earning dividends or interest just like it would if you hadn’t borrowed anything.
Are loans on life insurance taxable?
Loans taken from a life insurance policy are not taxable as income because the money you borrowed is considered a loan against the cash value of your policy, not income. However, a surrendered or lapsed policy with an outstanding loan may create a tax event if the loan balance exceeds the amount paid into the policy.
Here are some additional tips when taking out a policy loan:
- Monitor your loan balance regularly in comparison to your cash value.
- Formulate a disciplined loan repayment plan and make regular scheduled payments.
- Pay the interest on the loan every year to prevent your loan balance from increasing.
The ability to take loans on your policy is a valuable feature of permanent life insurance. Just be sure that your short-term needs don’t jeopardize your family’s financial protection.
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