While borrowing from your life insurance policy might be a quick and straightforward method to receive cash when you need it, there are a few details to be aware of before you borrow. The most notable limitation is that you may only borrow against a permanent or entire life insurance policy.
Term life insurance, which is a less expensive and more acceptable alternative for many individuals, has no cash value and expires at the end of the term, which can range from one to 30 years. However, in rare cases, term life insurance can be converted to whole life policies, which may qualify for a life settlement payment.
KEY LESSONS
Borrowing from your life insurance policy might be a fast and simple method to receive cash when you need it.
Borrowing against permanent or whole life insurance coverage is the sole option.
Policy loans are borrowed against the death benefit, and the policy serves as collateral for the loan.
Life insurance firms charge interest on the sum whether the loan is paid monthly or not.
Permanent life insurance is the only type that accumulates monetary value. Term insurance policies do not.
You Can Borrow Policies From
A whole life policy is more expensive than term life insurance, but it never expires. The term is for the duration of the insured’s life. While monthly premiums may be greater,
Money paid into the policy in excess of what is required for the death benefit is invested by the life insurance company, resulting in a cash value after a few years.
A whole life insurance policy has two values: the face value or death payout and the cash value, which serves as a savings account. When the amount invested exceeds the death benefit, the tax-free cash value can be borrowed against. It is also critical to realize that the policy loan is borrowed against your death benefit rather than withdrawn from it, and the insurance company utilizes your policy as collateral for the transaction.
The Process of Obtaining a Life Insurance Loan
Policy loans, unlike bank loans or credit cards, have no effect on your credit, and there is no approval procedure or credit check because you are effectively borrowing from yourself. Borrowing on your policy requires no explanation of how you intend to use the funds, so it may be used for anything from bills to vacation costs to a financial emergency.
The loan is also not considered income by the IRS, therefore it is tax-free (assuming it is not a modified endowment contract).
However, a policy loan is still expected to be repaid with interest, even if the interest rates are often considerably lower than on a bank loan or credit card, and there is no required monthly payment.
Because no cash is taken from your policy when you borrow against it, the cash value of your policy continues to rise as dividends are awarded. In some circumstances, dividends may be sufficient to cover loan interest.
Repaying the Loan
Even with low-interest rates and a flexible repayment plan, it is critical that the loan be repaid on time. Unless paid in full, interest is charged to the debt and accrues whether the bill is paid monthly or not, placing your loan at risk of surpassing the cash value of the policy and forcing your policy to expire.
Insurance companies often offer several options for keeping the loan current and preventing it from lapsing.
If the loan is not repaid before the insured person’s death, the loan amount plus any interest outstanding is deducted from the amount set aside for the beneficiaries of the death benefit.
In the case of an insurance lapse, taxes on the cash value must be paid.
INSIGHTS FROM ADVISORS
You can borrow money from a cash account in a life insurance policy while the insured is still alive. However, there are three traps to avoid:
Don’t diminish the death benefit: Withdrawing money from your life insurance policy while you’re still living may reduce the survivor payout.
Do not interfere with the warranty: Certain assumptions underpin permanent insurance promises.
The most important of these is that you will make your premium payments on time and amass a particular amount of cash. If you withdraw cash, you risk depleting the amount necessary to ensure the guarantee.
Don’t end up having to spend additional money: Some permanent plans may even guarantee the guarantee when you withdraw cash, but at a cost, that may cause you to pay a higher premium to make up the difference.
What is the maximum amount you may borrow against your life insurance policy?
Each insurance company has its own set of limitations, but in general, you can borrow up to 90% of the cash value of your life insurance policy.
When Can You Borrow From a Life Insurance Policy?
You can borrow from a life insurance policy as soon as there is enough cash value to cover the loan amount. This can take several years to accumulate depending on how your insurance is structured.
Which kind of life insurance policies can be used to secure a loan?
You can borrow from cash-valued permanent life insurance plans. Whole life and universal life (UL) policies are classic examples. Because there is no cash value linked with a term policy, you cannot borrow against it.
Can I Borrow Against My Term Life Insurance Policy?
No. There is nothing to borrow because term insurance does not have a cash value component.
In conclusion
In addition to the death benefit, permanent life insurance with a cash value might give certain living benefits. Among these include the possibility to borrow against the policy’s cash value. When you take a loan against your policy, unlike other forms of borrowing, your insurer lends you the money and uses the cash in your policy as collateral—you do not actually remove any money from the policy. This means that the cash value of the policy grows with dividends.
In rare situations, the profits may even be sufficient to pay the loan interest, making the borrowed money “free” in that regard. Of course, the loan will have to be repaid at some point. If you die, the loan amount and any interest outstanding will be deducted from your death benefit.
