How can I borrow money from my life insurance policy?
While borrowing from your life insurance policy can be a quick and easy way to get cash in hand when you need it, there are a few specifics to know before borrowing. Most importantly, you can only borrow against permanent or whole life insurance. Term life insurance, a cheaper and suitable option for many people, does not have a cash value and expires at the end of the term, generally anywhere from one to 10 years.
A whole life policy is more expensive but has no expiration date. The term lasts the lifetime of the insured. While the monthly premiums may be higher, the money paid in to the policy exceeding what is needed for the death benefit is invested by the life insurance company, creating a cash value after a few years. The whole life policy essentially has two values: the face value, or death benefit, and the cash value that acts as a savings account. Once the money invested increases the amount of the death benefit, the tax-free cash value can then be borrowed against. It is also important to understand that the policy loan is not taken out of your death benefit, but borrowed against it, and the insurance company is using your policy as collateral for the loan.
Unlike a bank loan or credit card, policy loans do not affect your credit and there is no approval process or credit check since you are essentially borrowing from yourself. When borrowing on your policy, no explanation is required about how you plan to use the money, so it can be used for anything from bills to vacation expenses. The loan is also not recognized by the IRS as income, therefore it remains free from tax. However, the policy loan is still expected to be paid back with interest, though the interest rates are typically much lower than on a bank loan or credit card, and there is no mandatory monthly payment.
Even with low interest rates and a flexible payback schedule, it is still important for the loan to be paid back in a timely manner. Unless it is paid out of pocket, interest is added to the balance and accrues whether the bill is being paid monthly or not, putting your loan at risk of exceeding the policy's cash value and causing your policy to lapse. Insurance companies generally give many opportunities to keep the loan current and prevent lapsing. However, in the event of a policy lapse, taxes must be paid on the cash value. If the loan is not paid back before the insured person's death, the loan amount plus any interest owed is subtracted from the amount the beneficiaries are set to receive from the death benefit.
You can borrow money from life insurance, that has a cash account for use, while the insured is alive. But you need to make sure you understand how these products work so that doing so doesn't backfire on you. Here are three pitfalls to avoid when you take cash out of life insurance:
1) Don't reduce the death benefit
Remember, life insurance is first and foremost a sum of money to take care of your heirs, estate, business, favorite charity, and all others who will carry on your legacy.
Taking money out of the life insurance policy while you are alive could very well reduce the survivor benefit. You don't want to short-change the beneficiary.
2) Don't tamper with the guarantee
Permanent insurance can have the unique feature of guaranteeing your coverage for the rest of your life. These guarantees are based on certain assumptions. Chief among these are that you will stick to a premium-paying schedule, and will keep the cash accumulating at a certain level.
If you take cash out of the policy, you may deplete the cash needed in the policy to ensure the guarantee. The coverage may not last as long as you want.
3) Don't force yourself to pay additional money
Some permanent policies will even ensure the guarantee when you take out cash. But the cost of providing you that guarantee will have to be covered somehow. They very well could ask you for additional premium payments to pick up the difference.
If they do this, then you will be paying more money into the policy than expected.
The moral of the story is this: get an understanding of what you want to use life insurance for – both the living and the death benefit – and make sure you are informed about the ramifications of tinkering with that strategy.
Please feel free to reach out to me with any additional questions.
This only applies to a permament policy, not term, just call the insurance company holding your policy and find out about the cash value and what is available to you. Make sure you aren't cashing out the policy which can trigger a taxable event.
The possibility of borrowing from your life insurance policy depends on the type of policy it is. If it is what's typically referred to as a whole life, universal, or variable universal policy, the answer is yes. If you borrow from one of these types of policies you are withdrawing from the cash value of the policy. There will be interest payable and may be additional fees assessed. You will need to pay the interest when due. If not paid, that may trigger a taxable event. Keep in mind that whatever is withdrawn and not paid back will be deducted from the death benefit.
If it's a term life policy, the answer is most definitely no.
If you have a cash value policy (whole life, universal life, etc.) that has cash value accumulated, you most likely can take a loan from the insurance policy. This can not be done with term insurance.
The cost and ramifications of the loan is included in the insurance contract/policy that you received. Before you take any loans, read the policy and call the insurance company and get guidance on how the loan will work, how much the interest will be and what your options will be. They can run an in-force illustration to show you the effect on the policy given many assumpesions like:
1) Interest rate for the loan,
2) How will it effect future dividends, growth or policy performance,
3) How it will effect the death benefit (or will you be putting your death benefit at risk.
I life insurance loan is typically tax free (unless it was set up as a Modified Endowment Contract - this is a tax term, but important to know if it is a MEC), but if there is a gain in the policy and if the loan causes the policy to lapse in the future, the gain may be realized on your tax return as ordinary income.
Some policies were designed to be very flexible for loans and some were not - be careful when taking loans from policies especially when the death benefit is important to your family or business.