When, how, and why to consider borrowing from your life insurance policy

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If you need funds to help start a business, pay college tuition, or anything else, you may not have to ask a bank for a loan. If you have permanent whole or universal life insurance – sometimes called "cash value life insurance" – in addition to providing valuable death benefit protection, the policy has a cash value that builds over time.1,2 Policy cash value is an asset that you can borrow against, and life insurance policy loans are typically easier to get than a bank loan. Plus, you don't have to tell the lender what you want to do with the money. However, there are other advantages to a policy loan, and there can be disadvantages as well. This article can help you understand:

How to get a life insurance policy loan

For starters, you have to have the right kind of life insurance policy. There are two main types of life insurance: term life and permanent life. Only permanent policies build cash value. Term life insurance is less expensive, but coverage is temporary, and there's no cash value component, so there's nothing to borrow money against. That's why term life is sometimes called "pure life insurance": it's designed to provide an insurance payout for your beneficiaries if you pass away (the policy's death benefit) but nothing else. 

Permanent life insurance policies are available in two primary forms: whole life insurance and universal life insurance. With these policies, part of your money goes toward a cash value every time you pay a premium, where it builds over time. The rate of cash value growth varies by policy: with whole life, there is typically a set rate of interest, while in some universal policies, cash value growth can be tied to market investments. Either way, the cash value grows tax-deferred - like a retirement account.3 But unlike with IRAs, it can be easy to use the cash value as collateral for a loan.

When can you get a policy loan?

You can take a loan against your policy anytime it has enough value.  It may take several years before the cash value grows into a useful amount.

How do you apply for a policy loan?

The application process tends to be relatively easy, and your insurance agent can help with any issues. Generally speaking, you have to fill out a simple form, either on paper or online, verify your identity, and submit it. Unlike a traditional loan, there's no income or credit check, and your credit score does not affect approval or the interest rate. Because it is fully collateralized by your policy's cash value, the approval process is generally quick, and the loan interest rate is typically lower than a personal loan or even a home equity loan. The money may be deposited into your account within a few days.

Policy loan considerations and how much you can borrow

Each life insurance company sets its own rules about how much money you can borrow from your policy, but you can typically get a policy loan for up to 90% of the value in your policy. And unlike most loans, there's no set repayment period: you can pay it back in ten months, ten years, or longer -- but if you pass away in that time, any outstanding loan balance will typically be deducted from your death benefit.

Money isn't taken out of your policy

Loan funds don't actually come out of your policy but rather from the company itself who uses your policy as collateral. Since money stays in your policy, it earns interest and grows tax-favored. At the same time, however, you're charged interest on your policy loan. If you don't repay the annual interest, that sum will be added to your loan amount.

What if you decide not to pay back the loan?

You have the option not to repay, but it may not be your best course of action. Interest compounds over time and is added to your loan balance, further lowering your death benefit. And if the total loan balance grows to be larger than your cash value, the policy could lapse. When your policy lapses, the cash you took out may be treated as income, and you could owe taxes on it.

As a rule, life insurance loans can be a more intelligent and accessible option than traditional loans. Qualification is easier compared to a personal loan, and it can be more cost-effective than carrying high-interest credit card debt. However, if you don't want to risk losing your life insurance protection, you have to repay what you borrowed. If you'd rather not pay back a loan, there are other ways to access your policy's cash value (see below).

Life insurance policy loans:

The advantages

Easy qualification

As long as your cash value is above the minimum required by your insurer for policy loans, approval is essentially automatic with no credit checks or application fees.

Quick access to funds

Cash can be deposited into your account within a few days. You can even use it for stop-gap financing. For example, if you're waiting for approval of another loan but need money immediately, you can quickly take out a policy loan and repay it when the traditional loan comes through.

Lower interest

Since there's essentially no risk to the loan issuer, interest payments and rates are generally lower than when you borrow money with other types of loans.

No set loan repayment schedule

You can use it as a short-term bridge loan while you wait for other financing to come through, or you can take your time and repay over several years.

The disadvantages

Less life insurance protection during the repayment period

If you pass away while there's an outstanding loan balance, it will typically be deducted from the full death benefit.

Risk of policy lapse

As long as you just pay interest on the loan amount (along with your normal premiums), this isn't an issue. However, if you make no loan payments at all, the unpaid accumulated interest is added to the loan amount, and you could eventually owe more than the value of your policy. This will cause the policy to lapse.

Other ways to access cash value from a life insurance policy

Borrowing money against cash value is just one of several ways to use this flexible policy asset. Generally speaking, there are three other common ways to access the cash value in a universal or whole life insurance policy:

Cash surrender

One option is to cancel the policy entirely and take the surrender value cash payment, leaving you without life insurance coverage. This option may be considered for people in retirement who need cash to live on and no longer have dependent children. But check the policy contract first: there can be significant surrender fees, especially with a newer policy. Also, if you're thinking about surrendering the policy because you no longer want to pay premiums, consider using the cash value to cover your premium payments instead (see below).

Withdrawal 

In many situations, you can take a cash withdrawal from your permanent life policy, and that money is often not subject to income taxes (as long as it's not more than the premiums you've paid into the policy). However, there are potential disadvantages: your death benefit will likely be reduced, , and that reduction may be greater than the amount withdrawn, depending on the specific terms of your policy. Talk to your agent or life insurance company to find out how withdrawing money from your specific policy works. 

Use the cash value to pay your insurance policy premiums

You can typically use the money in your cash value to pay part or all of your policy premiums, making it much easier to keep your coverage in place. This is a popular option for older policyholders who want to lower their expenses in retirement but still wish to keep life insurance coverage in place. 

Now that you know more about how a universal or whole life insurance policy can be used for borrowing and as a wealth-building asset, you may want to explore what kind of policy is best for your family's needs. Consider talking with a knowledgeable professional who will take the time to learn about your financial situation and goals, then help guide you to the right solution. If you don't have a financial professional to discuss insurance with, Guardian can help you find a nearby financial representative who can help.

Frequently asked questions about borrowing from a life insurance policy

What is the advantage of taking out a loan against a life insurance policy?

Actually, there are several advantages to borrowing against your policy's accumulated cash value, especially when compared to other types of loans. First, the application process is generally easier - you don't have to provide a reason for the loan, and there's no income or credit check. Second, approval tends to happen quickly, and you may have funds deposited in your bank account in just a few days. Third, you may likely pay interest at a lower rate than other loans. Finally, repayment terms are generally flexible: you can take as long as you want to pay the money back.

How much money can I borrow from my life insurance?

This will vary depending on how much cash value you have, the type of policy you own (for example, you can borrow against whole life, but not term life insurance), how long you've had the policy, and the insurance company's rules regarding loans. For example, some policies may not have sufficient value to loan against in the early years. You can typically access up to 90% of the policy’s cash value.

Note that there is a difference between the death benefit – or "face value" – and the cash value of life insurance. Part of each month's premium pays for your life insurance benefit, and part goes to the cash value. The policy's cash value equals part of the premiums paid in, plus any tax-deferred growth.

Do you have to pay back loans on life insurance?

Repayment of a life insurance loan is not required, but it's typically in your interest to do so because the outstanding loan amount detracts from the death benefit. Also, as loan interest compounds over time, the total balance may grow larger than your cash value, causing the policy to lapse. In that event, the cash you took out may be treated as income, and you could owe taxes on it.

Can you cash out a life insurance policy before death?

If you have a permanent life insurance policy, then yes, you can take cash out before your death. In addition to the policy loans described above, you can take out cash value in the form of a withdrawal, either in a lump sum or in payments. As with a policy loan, your death benefit will generally be reduced. The last option is to surrender the policy for cash. Unless you are past retirement age, surrender should be considered a last resort, as this cancels the policy along with your life insurance coverage. With surrender, you may also pay taxes and fees, which can significantly reduce your cash value in a newer policy.

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Disclaimer

This article is for informational purposes only. Guardian may not offer all products discussed. Please consult with a financial professional to understand what life insurance products are available for sale.

1 Some whole life polices do not have cash values in the first two years of the policy and don’t pay a dividend until the policy’s third year. Talk to your financial representative and refer to your individual whole life policy illustration for more information.

2 Policy benefits are reduced by any outstanding loan or loan interest and/or withdrawals. Dividends, if any, are affected by policy loans and loan interest. Withdrawals above the cost basis may result in taxable ordinary income. If the policy lapses, or is surrendered, any outstanding loans considered gain in the policy may be subject to ordinary income taxes. If the policy is a Modified Endowment Contract (MEC), loans are treated like withdrawals, but as gain first, subject to ordinary income taxes. If the policy owner is under 59 ½, any taxable withdrawal may also be subject to a 10% federal tax penalty.

3 Guardian, its subsidiaries, agents and employees do not provide tax, legal, or accounting advice. Consult your tax, legal, or accounting professional regarding your individual situation.

2021-131143  20220915