Can I Borrow Against My Life Insurance Policy?
Yes you can! Our team at Affordable Burial Insurance Life is happy to work with you to determine if a loan from your life insurance policy makes sense for you. A loan from your life insurance policy works by allowing you to borrow money against the cash value that has accumulated in your policy. The loan is typically offered at a low-interest rate and doesn’t require a credit check, making it an attractive option for policyholders who need access to funds. However, it’s important to understand how these loans work and the potential impact they can have on your policy.
Here’s a breakdown of how a life insurance policy loan works:
1. Loan Availability
- Loan Against Cash Value: You can borrow against the cash value of your permanent life insurance policy (such as whole life or universal life). Term life insurance policies typically don’t have cash value, so they don’t offer loans.
- Loan Amount: The amount you can borrow is usually a percentage of the available cash value in the policy. Generally, you can borrow around 90-95% of the cash value, though this can vary by insurer and policy type.
2. Interest Rates
- The loan is charged interest by the insurance company. The rate can be either fixed or variable, depending on the terms of the policy. Interest rates are generally lower than credit card rates, making life insurance loans a more affordable option for borrowing.
- Interest accrues on the outstanding loan balance, and the interest rate is typically lower than many other types of loans because it’s secured by the policy’s cash value.
3. Loan Terms and Repayment
- Flexible Repayment: Life insurance loans have flexible repayment terms. Unlike traditional loans, you are not required to make regular payments. Instead, you can choose when to repay the loan, and you can repay it partially or in full at any time.
- No Set Repayment Schedule: If you choose not to repay the loan, it will not affect your credit score, as there’s no formal repayment schedule. However, any unpaid loan balance, including accrued interest, will be deducted from the death benefit when the policyholder passes away.
- Interest Payments: While there’s no required repayment schedule, interest on the loan must be paid periodically to prevent the loan from growing too large. If you don’t pay the interest, it will accumulate and be added to the loan balance.
4. Impact on the Death Benefit
- Loan Balance Deduction: If you don’t repay the loan, the outstanding balance (loan principal plus any accumulated interest) will be deducted from the death benefit that your beneficiaries receive upon your death. For example, if your death benefit is $100,000 and you have an outstanding loan of $20,000, your beneficiaries will receive $80,000 after your death.
- If the loan balance exceeds the cash value, your policy could potentially lapse, which means your insurance coverage would end, and you could lose both the coverage and any remaining cash value.
5. Tax Considerations
- Tax-Free Loan: Generally, loans taken from a life insurance policy are not taxable as long as the policy remains in force and does not lapse. This is because the IRS treats these loans as borrowing against your own money (the cash value).
- However, if the policy lapses or is surrendered with an outstanding loan balance, the amount of the loan that exceeds the amount of premiums paid (the cost basis) may be subject to income tax. This is particularly true if the policy becomes a Modified Endowment Contract (MEC), which causes loans and withdrawals to be taxed.
6. Loan Example
Let’s say you have a whole life insurance policy with $50,000 in cash value. The insurance company allows you to borrow up to 90% of the cash value, which in this case would be $45,000.
- Borrowing: You take a loan of $20,000 against the cash value.
- Interest: The loan accrues interest at 5% per year. After one year, the loan balance would be $20,000 + $1,000 (interest) = $21,000.
- Repayment: You decide not to repay the loan immediately. At the time of your death, your beneficiaries will receive the death benefit, but it will be reduced by the loan balance (plus any accumulated interest). For instance, if your death benefit was $50,000, they would receive $50,000 - $21,000 = $29,000.
7. Advantages of Life Insurance Loans
- No Credit Check: Life insurance loans are not dependent on your credit score or credit history, making them an easy borrowing option.
- Flexible Repayment: There’s no formal repayment schedule, so you can repay the loan whenever you have the means.
- Low-Interest Rates: The interest rates on life insurance loans are typically lower than those of personal loans, credit cards, or other borrowing options.
- Tax-Free Loans: Loans are generally not taxed as income, providing a tax-advantaged way to access funds.
8. Risks of Life Insurance Loans
- Reduced Death Benefit: If you don’t repay the loan, it will reduce the death benefit paid to your beneficiaries, which could leave them with less than you intended.
- Policy Lapse: If the loan balance (including interest) exceeds the cash value of the policy, your policy could lapse, meaning you would lose both your coverage and any accumulated cash value.
- Interest Accumulation: If you don’t pay the interest on the loan, it will accumulate and be added to the loan balance, which could grow quickly over time and negatively affect the policy.
9. Considerations Before Taking a Loan
- Loan Impact on Your Financial Plan: Before taking a loan, consider how it will impact your long-term financial goals, both in terms of the cash value and the death benefit.
- Repayment Plans: While there are no mandatory payments, it’s a good idea to develop a plan for repaying the loan to prevent it from affecting your policy's cash value or death benefit.
- Use of Loan: Loans should be considered carefully to ensure that you are borrowing for the right purposes and that you understand the impact on your policy’s financial health.
Summary
- A life insurance loan allows you to borrow against the accumulated cash value of a permanent life insurance policy (whole life or universal life).
- The loan typically comes with low-interest rates, and repayment is flexible. However, any unpaid loan balance (including interest) will be deducted from your policy's death benefit.
- Loans are generally not taxed, but there are risks, including the potential for your policy to lapse if the loan balance exceeds the cash value.
- It’s important to carefully consider the impact of taking a loan from your life insurance policy on both the policy’s value and your beneficiaries’ death benefit.
Life insurance loans can be a useful financial tool, but they should be managed carefully to avoid unintended consequences. Click the following link to schedule a call with one of our team members: