Whileborrowing from your life insurance policycan 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 a permanentlife insurance policy, meaning either a whole life insurance or universal life insurance policy.
Term life insurance, a cheaper and more suitable option for many people, does not have a cash value. It is designed to last for a limited period of time, which is generally anywhere from one to 30 years. However, in some instances, a term life policy can be converted to a permanent policy in which cash value can build.
Key Takeaways
Borrowing from your life insurance policycan be an easy way to get cash in hand when you need it.
You can only borrow against a whole life insurance policy or a universal life insurance policy.
Policy loans reduce the death benefit if not paid off.
Life insurance companies add interest to the loan balance, which if unpaid can cause the policy to lapse.
Only permanent life insurance builds cash value. Term policies do not.
Policies You Can Borrow From
Both whole life and universal life insurance policies are more expensive than term, but have no pre-determined expiration date. If sufficient premiums are paid, the policy is in force for the lifetime of the insured. While the monthly premiums are higher than term, money paid into the policy that exceeds the cost of insurance builds in a cash value account that's part of the policy. The purpose of the cash value is to offset the rising cost of insurance as you age. This is so premiums can remain level throughout life and not rise to unaffordable amounts in your later years.
Permanent life insurance has a few important values: the face value, the death benefit (often the same as the face value), and the cash value. One common misconception is that the cash value increases the death benefit. This is only true on certain types of permanent policies; on most policies it does not increase the death benefit.
Money in the cash value grows at a rate that depends on the type of policy. For example, in a regular universal life policy, it grows based on current interest rates, while in a variable universal life policy, the cash value is invested by the owner in the stock market (and grows accordingly). It usually takes at least a few years for the cash value to build to sufficient levels to take out a 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 to a financial emergency.
The loan is also not recognized by the IRS as income, therefore it remains free from tax as long as the policy stays active (provided it's not a modified endowment contract).It's still expected that a policy loan will 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.
A policy loan reduces your available cash value and death benefit. If you pass while owing money on a life insurance loan, it will reduce the amount your beneficiaries receive.
Paying Back the Loan
Even with low interest rates and a flexible payback schedule, it's important that you pay the loan back in a timely manner—on top of your regular premium payments. If unpaid, interest is added to the balance and accrues, putting your loan at risk of exceeding the policy's cash value and causing your policy to lapse. If that happens, it's likely you'll owe taxes on the amount you borrowed.
Insurance companies generally provide many opportunities to keep the loan current and prevent lapsing. 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.
Advisor Insight
Steve Kobrin, LUTCF The firm of Steven H. Kobrin, LUTCF, Fair Lawn, NJ
You can borrow money from life insurance that has a cash account for use while the insured is alive. But here are three potential pitfalls:
You reduce the death benefit: Taking money out of the life insurance policy while you are alive could reduce the survivor benefit.
You tamper with the guarantee: Permanent insurance guarantees are based on certain assumptions. Chief among these is that you will stick to your premium payments and accumulate cash at a certain level. If you take cash out, you may deplete the amount required to ensure the guarantee.
You end up paying more money: Some permanent policies will even ensure the guarantee when you take out cash, but at a cost that could force you to pay more premium to cover the difference.
How Much Can You Borrow Against Your Life Insurance Policy?
Each insurance company will have different rules in place, but in general, the most you can borrow against your life insurance is up to 90% of its cash value.
How Soon Can You Borrow Against a Life Insurance Policy?
You can borrow from a life insurance policy as soon as there is enough cash value built up to take a loan in the amount you need. Depending on how your policy is structured, this can take several years to accrue.
Which Types of Life Insurance Policies Can You Borrow Against?
You can borrow from permanent life insurance policies that build cash value. These would typically include whole life and universal life (UL) policies. You cannot borrow against a term policy since there is no cash value associated with it.
Can I Borrow Against a Term Life Policy?
No. Because term insurance does not have a cash value component, there is nothing to borrow.
The Bottom Line
Permanent life insurance that accumulates a cash value can provide certain living benefits, in addition to its death benefit. Among these include the ability to borrow against the cash value of the policy and to make cash value withdrawals. When you take a loan against your policy, your insurer lends you the money and uses the cash in your policy as collateral—you do not actually withdraw any money from the policy itself. This means that the policy's cash value can continue to accumulate—but it's important to check with your insurance company how interest and any dividends will be determined and paid when you have an active loan.
Policy loans can be useful financial tools, but they can also create financial turmoil. If you don't make interest payments, your policy could lapse and the entire loan amount could become taxable. And if you pass away, the loan amount and any interest owed will be taken out of the death benefit, which could significantly impact your beneficiaries. Be sure to thoroughly consider the pros and cons of life insurance policy loans in the context of your situation before taking one out.
You can typically take out loans against permanent life insurance policies, but not term life insurance policies. Life insurance loans use cash value accounts as collateral. Term life insurance policies do not come with a cash value account, so policyholders can't borrow money from their insurer against these policies.
Can you borrow against life insurance immediately? No, you cannot immediately borrow against life insurance. You must wait until your policy's cash value exceeds a certain threshold, and it can take several years to reach that point. The minimum cash value required for a policy loan varies by insurer.
Life insurance loans are only available on permanent life insurance policies — such as whole life and universal life — that have a cash value component. You likely can't borrow against a term life insurance policy since it probably doesn't have cash value. Learn more about term vs. whole life insurance.
The $10,000 refers to the face value of the policy, otherwise known as the death benefit, and does not represent the cash value of life insurance policy. A $10,000 term life insurance policy has no cash value.
Yes, it can be done. If you have the right type of life insurance – whole life or universal life – and have been making on-time payments to it for an extended period, you may have accrued enough “cash value” in the policy to bury your credit card debt.
Yes, life insurance policy loans generally need to be paid back, though there is some flexibility in how repayment may occur. Policyholders are generally expected to repay the loan principal and interest during their lifetime. This allows the full death benefit to remain intact for beneficiaries.
Life insurance loans typically don't affect your credit because your policy is the collateral for the loan, and there's no set repayment schedule. There's no loan approval process, which means your credit score is unaffected when you get the loan.
If you have a permanent life insurance policy with cash value, you can generally take out a policy loan. You can use the loan to pay off a debt or for any other purpose. You repay the policy loan, with interest, or the death benefit for your beneficiaries will be reduced to cover the borrowed amount.
How long does it take to build cash value on life insurance? The length of time varies by insurer, but in most cases, cash value does not start to accrue until you have paid premiums for two to five years.
The amount you can borrow depends on the cash value of the policy. Typically, the insurer will let you borrow up to 90% of the cash value. However, in some cases, they might allow you to borrow up to 100% of the cash value. Check your policy and talk with your life insurance agent to determine how much you can borrow.
If you're considering how to use life insurance to build wealth, then you can start by looking for a policy with a cash value component. For cash value accounts, the insurer takes part of your insurance premium and puts it into an account intended to increase in value over time.
You can take out life insurance loans against the value of the death benefit within a life insurance plan. The death benefit is the portion of money paid to the beneficiary when the life insurance policy owner passes. The value of the life insurance policy itself is used to help guarantee the loan will be paid back.
You can borrow from a life insurance policy as soon as there is enough cash value built up to take a loan in the amount you need. Depending on how your policy is structured, this can take several years to accrue.
Is life insurance cash value taxable? Fortunately, the cash value of life insurance grows tax-free. This means that, in many cases, you won't have to worry about paying taxes on it.
You can cash out a life insurance policy. How much money you get for it will depend on the amount of cash value held in it. If you have, say $10,000 of accumulated cash value, you would be entitled to withdraw up to all of that amount (less any surrender fees).
Permanent life insurance policies will allow you to access the cash portion of your account while you're alive. Term life insurance, meanwhile, does not have a cash element for policyholders to access. So, if you're planning on using your life insurance as a backup cash resource you'll want to avoid term policies.
Can you cash out a life insurance policy before death? If you have a permanent life insurance policy that has accumulated cash value, then yes, you can take cash out before your death. There are three main ways to do this. First, you can take out a loan against your policy (repaying it is optional).
Although the rates may be favorable, you still pay interest on life insurance loans. And because the interest is often subtracted from the cash value, it can sneak up on you. If your loan plus interest exceeds your policy's cash value, the policy could lapse.
There are four ways to get the cash from your policy while you're still alive: borrow, withdraw, surrender, or sell. Before you decide to draw cash from your policy, be sure you understand the pros and cons of your decision.
A life insurance loan is not taxable unless the loan amount is greater than what you've paid in premiums. However — and this is important — the loan will become taxable if you surrender or lapse your coverage.
A typical life settlement is worth around 20% of your policy value, but can range from 10-25%. So for a 100,000 dollar policy, you would be looking at anywhere from 10,000 to 25,000 dollars.
When this happens, your beneficiaries lose their inheritance from the life insurance, and you lose the opportunity to use the money again in the future. In addition, if you don't pay the loan back and the amount you borrow reaches the amount of cash value (or exceeds it), you may find yourself owing taxes.
To make the infinite banking concept work for you, simply request a loan from your life insurance policy. This is accomplished by submitting a policy loan request form. Once they verify the funds available in your life insurance cash value, the insurance company sends you a check or processes it electronically.
The timeline for borrowing against a life insurance policy depends on the type of policy and how quickly it accumulates a cash value. Typically, it takes time for the cash value to build up. Often, it can take many years or upwards of a decade to build up a sufficient cash value to make borrowing worthwhile.
You can typically take a loan against your index universal life insurance policy's cash value as soon as it exceeds your insurer's minimum requirement. It's crucial to ensure the loan amount leaves enough cash value to maintain your life insurance coverage and cover fees.
You will typically find it listed separately in your life insurance statements. The net cash value will generally be lower than your total accumulated cash value for the first several years of coverage, as it's reduced by fees and surrender charges.
How much is a million-dollar life insurance policy? The average monthly premium for a million-dollar life insurance policy is anywhere from about $50 to more than $1,000, depending on the type of policy, age, health, and other factors.
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