Borrowing Against an Insurance Policy

A benefit of purchasing permanent life insurance is the ability to take out a loan against the policy in the event of a financial emergency. Whole life and universal life insurance are types of permanent life insurance plans that accumulate cash value as the policy owner pays premiums, and the owner can borrow against that cash value. If you decide to take a loan out against your permanent life insurance policy, there are a few things to keep in mind.

First, let’s discuss the difference between permanent life insurance and term life insurance. Permanent life insurance plans combine a death benefit and a savings portion. The premium paid goes toward paying for the insurance and toward the savings portion. Permanent life insurance plans can build cash value and do not expire.

Term life insurance plans cover the policy owner for a set time period and do not build cash value, because the entire premium paid goes toward the cost of the insurance. The policy expires after the term is up, though there are generally options to extend the policy.

Taking out a loan against a permanent life insurance policy has several benefits.

The money can be used for anything from paying for a child’s college expenses to paying for a vacation. The IRS doesn’t recognize the loan as income, so you don’t have to pay taxes on the money.

You don’t have to be approved for the loan, and there is no credit check. There are repayment options including principal and interest payments, interest only payments and using the cash value to make interest payments.

When paying back the loan, you are essentially paying yourself back, so interest rates on the loan are generally lower than they would be if you took out a bank loan or used a credit card. There isn’t a timetable to repay the loan, and while it’s not always advisable, you don’t necessarily have to pay it back.

If you do decide to take out a loan against your insurance policy, there are some potential pitfalls you should be aware of.

The cash value of an insurance policy builds over time, so there might not be sufficient cash value available to borrow against if you want to take out a loan in the first years of the plan.

While there is no requirement or timetable to pay back the loan, the interest on the loan will continue to accrue on the outstanding balance. If the policy owner dies before the loan is paid back, the death benefit will be reduced by the outstanding loan amount.

The accruing interest on the loan balance could put the policy in jeopardy of lapsing if the loan amount ends up exceeding the cash value of the policy, so even if you decide not to pay the loan back in full, it is generally advisable to at least pay the interest to keep the loan amount from growing.

A permanent life insurance policy can prove a useful tool if you need a quick way to get cash, but be mindful of the impact the loan can have on the policy and on the benefit your beneficiaries will receive should the loan not be paid back in full.

Our financial planners at Insight Wealth Strategies will meet with you to discuss your specific situation to determine the best course of action. Please contact us at (925) 659-8020 with specific questions or to schedule a time to meet in our San Ramon, CA or Houston, TX offices.