How To Monitor A Life Insurance Policy Loan
The insurance company will not require you to pay back the loan balance. Nor do they provide any loan repayment schedule. You have the option each year to pay loan interest out-of-pocket or to borrow the interest. If you choose to borrow the interest, the loan balance will compound, which means that the interest due each year will compound.
Its important to request an in-force policy illustration annually to determine the impact of a policy loan. Your request should include the following scenarios along with any others that reflect your plans:
Re-paying the policy loan in-full
Paying premiums and interest out-of-pocket
Borrowing future premiums and loan interest
Showing what happens if your current premium payments stay the same
Showing the premium needed to endow the policy at maturity
Any other action youre considering, such as taking a partial withdrawal or changing your dividend option
Policies You Can Borrow From
A whole life policy is a more expensive type of life insurance, but it has no expiration date. The term lasts the lifetime of the insured. While the monthly premiums may be higher, money paid into the policy that exceeds what is needed for the death benefit is invested by the life insurance company, creating a cash value after a few years.
A 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 uses your policy as collateral for the loan.
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No Credit Check Required
Its your money, to begin with, so your insurer wont have to pull out your credit report. Also, your policy loan wont appear on your credit report.
Traditional loans and credit cards, on the other hand, require hard credit checks. These hard checks can have a negative impact on your credit score. Whats more, once issued, such loans and credit cards will show up on your credit report.
Can You Borrow Against Your Life Insurance Policy
The cash value in a life insurance policy is equivalent to the amount of money you would receive if you surrendered the policy. Each time you pay premiums for a cash value life insurance policy, such as whole or universal life insurance, part of the premium is put towards the cash value.
The cash value grows over time at an interest rate set by the policy’s terms. If you have a permanent life insurance policy that accumulates cash value, you can borrow money from the insurer using the cash value as collateral. However, this option is typically only available once your life insurance policy’s cash value has reached a specific size, which may take five to 10 years of paying premiums.
Term life insurance policies are cheaper than permanent policies because they don’t have a cash value component. You can’t borrow against them, and if you decide to surrender a term life insurance policy, you won’t receive money in return.
What Is Cash Value Life Insurance
Unlike term life insurance, which pays out only if you die during the policy term, permanent life insurance policies sometimes called cash value life insurance pay out no matter when you die. Part of your premium goes into a separate account that builds up cash value.
When theres enough cash value, you can use it to:
Buy more coverage to boost the death benefit
The Pros And Cons Of Borrowing From A Whole Life Policy
There can be both pros and cons when it comes to borrowing against a whole life insurance policy.
- Benefits of borrowing may include, but are not limited to:
- It can be a quick and convenient way to get cash when needed2
- As stated previously, typically, theres no credit check3
- Interest rates are usually low3
- There is no timetable on when loans must be paid back3
- However, the downside of borrowing may include, but are not limited to:3
- At first, there may be little to no cash value to borrow against
- If you dont repay the loan during your lifetime, your death benefit will be reduced
- Theres always a risk of losing coverage, from interest sneaking up on you
- Your policy can lapse if your loan plus interest exceeds your policys cash value
- Potential tax consequences
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When A Policy Loan Makes Sense
When you take out a life insurance loan, youâre not actually withdrawing from your life insurance. Instead, the insurer extends you the loan, using your cash value as collateral.
“I typically would recommend a client take out a loan against an insurance policy if they are at a point where they no longer need the death benefit to cover the people they initially purchased it for,” says Malcolm Ethridge, executive vice president and financial advisor at CIC Wealth. “For instance, a retired couple whose home is paid off and children are financially independent likely does not have a need for a large death benefit once they pass away. The same with a widow or widower.”
A policy loan is also worth considering if you donât want to put up other assets, like a car, as collateral for a loan, or if you wouldnât qualify for a loan elsewhere.
You Incur Interest But Payback Is Open
As you’d expect, you will pay interest on your life insurance loan. The rate is set by the insurance company and could range from 4% to 8%. Often, the insurer will bill you for the interest annually on your premium renewal date. If you don’t pay the interest charges, they’ll be added to your loan balance where they’ll accrue additional interest. That can snowball quickly, eating up your death benefit in the process.
What you might not expect is that the insurer won’t establish a payback schedule for the principal. It’s up to you how and when you repay those funds. Technically, the loan repayment is usually optional, but there are advantages to doing so. You’d restore the death benefit and end the accrual of interest charges.
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What Is A Life Insurance Policy Loan
Policy loans are available on most permanent cash value life insurance policies. Policy loans are not the same as other loans: Policy owners are not required to repay the loan. Keep in mind, the insurance company will charge interest on the policy loan.
When you borrow money from your life insurance policy, you are borrowing your own money. It is essentially an advance of money that could be received from the policy either through a surrender of the policy or the payment of the death benefit. It is money that you, or your beneficiary, would have received anyway. The policys cash value acts as collateral for the policy loan.
If you never pay back the policy loan during your lifetime, the amount is deducted from the death benefit when you pass awaymeaning that your beneficiaries repay the loan.
In Board of Assessors v. New York Life Insurance Company , U.S. Supreme Court Justice Oliver Wendell Holmes wrote: The so-called liability of the policyholder never exists as a personal liability, it is never a debt, but is merely a deduction in account from the sum the plaintiffs ultimately must pay.
Why Is A Life Insurance Policy Loan Dangerous
The in-force policy illustration will help you determine how long your policy will remain in-force. You will find that the larger the loan, the more impact it will have on your policy.
For example, with an initial policy loan of $50,000 and a loan interest rate of 8%, the loan interest in year 1 will be $4,000. If you borrow the loan interest, your loan balance would increase to $54,000 . The loan interest in year 2 would increase to $4,320. The loan balance would increase to $58,320, if the loan interest is borrowed again . As you can see, this rapidly increases the policy loan balance
Heres how it works:
On a permanent cash value life insurance policy, the cash value increases every year. This reduces the total risk to the insurer because it will pay out only the death benefit when you pass away and absorb the cash value. Mortality coststhe actual cost of insurance for youare also increasing each year because you get older. But that increase is usually offset for the insurer by the decreasing amount at risk.
If youve taken out a loan from the cash value, the lower cash value will result in lower earnings. If your premium payments arent enough to cover the mortality cost and other fees, the insurer will take it from your cash value. Now your cash value is being depleted by multiple demandsthe loan, lower earnings and fees. And if the cash value goes to zero the policy will terminate, unless you make an infusion of premium.
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What Is A Life Insurance Loan
Simply put, a life insurance loan is a loan that you take out using the accumulated cash value in your life policy as collateral.
A life insurance loan is only available in cash value policies such as whole life insurance, universal life insurance or variable universal life insurance. It is not possible to take out a loan against a term policy because it only offers pure death benefit protection and does not have any cash value.
Life insurance loans generally allow you to withdraw more than you can get if you make a direct withdrawal from your policys cash value because there are no costs and fees deducted.
However, as with any other type of loan, a loan against your cash value will charge you interest that comes out of your remaining cash value.
For example, if you have $5,000 of cash value in a universal life insurance policy, you might be able to make a maximum direct withdrawal of $4,500, with the other $500 either remaining in the policy or being used to pay for administrative expenses.
But you could instead take out a life insurance loan for the entire $5,000, and the interest charged on the loan would come out of the $5,000 that is still inside the policy.
It should be noted that loans cannot be taken out on term life insurance policies, because they have no cash value. These policies only offer pure death benefit protection for a set period of time.
How Does Borrowing Against A Whole Life Insurance Policy Work
A whole life insurance policy doesnt expire, as long as the premium is paid.1 In other words, it will last the lifetime of the insured.
The money thats paid into the policy gets invested by the life insurance company2 and has a cash value benefit that increases over time. Since it happens over a period of time, this allows the owner to borrow against that cash value.
Whole life policies essentially have two values the face value or death benefit, and the cash value. Once the death benefit amount has increased, the cash value usually can typically be borrowed against.1 Your policy is used as collateral for the loan by your insurance company.
The Tax Implications Of Borrowing Against Your Life Insurance
The IRS has mandated that there are no income tax consequences of any kind when you take out a loan from your life insurance policy. The money that you receive is considered to be a tax-free return of principal.
However, this is not the case if you make a direct withdrawal from your policy or surrender your policy in full. You will most likely have a tax bill if you use either of these methods to access your cash value. Keep in mind, the loan interest that you pay for your withdrawal is also nondeductible.
Should I Pay Back My Whole Life Insurance Loan
In theory, the money you are allowed to borrow from your whole life insurance policy is yours. A whole life insurance loan uses your loan as collateral. If you don’t pay it back, the policy will eventually lapse. 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 , you may find yourself owing taxes.
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Borrowing Against A Life Insurance Policy
You can take a loan on the cash value of a life insurance policy without needing to go through a credit check. But any unpaid balance will subtract from the death benefit. In this scenario, it’s important to balance your current needs against your long-term goals.
Potential uses for a loan taken out against a life insurance policy include paying off a home mortgage, covering a child’s college tuition or taking a vacation. You’ll be charged interest on the loan, usually in the range of 5% to 8%. If the loan and interest aren’t paid before you die, the loan balance and fees will be deducted from the death benefit.
You aren’t required to pay back a life insurance loan, but interest will keep accumulating until it’s paid off or until you die.
There Are No Qualifiers For A Policy Loan
Unlike other loans, you don’t need to qualify to borrow against your life insurance policy. There’s no credit check, so the loan doesn’t appear on your credit report. And you don’t have to provide proof of income. At most, you’ll just have to prove your identity and that you’re requesting the loan.
Since there are no checks or qualifications, life insurance collateral loans can be a great solution if you need money quickly, such as for an emergency medical expense. Alternatively, they can be used as a stop-gap if you’re applying for a loan elsewhere, taking a long time to be approved.
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An Example Of Borrowing From A Life Insurance Policy
When Jane called to get the loan and discuss it with her financial advisor, she found out that she could borrow the money without a problem. But she also learned that the amount might reduce the amount of her death benefit. This reduction would mean that, if she were to die, her family would only get the death benefit minus the amount of the loan she hadn’t yet paid.
Jane’s advisor also explained that, even though she didn’t have to pay back the loan, she could end up paying interest and compounded interest. When they worked out the details, Jane decided that the loan for the sailboat wasn’t the best use of her accumulated cash value.
Instead, Jane chose to take money from her life insurance policy to start her own business. Because she had already done market research and had some demand for her services, she felt confident that she could pay back her loan within two years.
Can I Borrow Against My Universal Life Insurance
- Asked October 25, 2013 in
Contact Peggy Mace Contact Peggy Mace by filling out the form below
Peggy MacePROMost of the U.S.Yes, you can borrow against Universal Life Insurance, as long as there is enough cash value accumulation from which to borrow. You must be careful to observe policy guidelines so that you do not lose the guaranteed death benefit. Some people borrow from Indexed Universal Life as a source of tax favored retirement income.Answered on October 28, 2013+1
Contact Timothy Hider Contact Timothy Hider by filling out the form below
Timothy HiderFounder, Momentum Risk Transfer, Garden City, NYThe short answer is yes, you can borrow money from your universal life insurance policy, or other permanent – cash value life insurance policies. Understand the mechanics and costs associated with borrowing from your policy. This is an area that many agents and consumers are not all that familiar. You do not want to incur taxes as a result of borrowing too much and/or lapsing your policy. Consult with an experienced life insurance agent to help determine the best course of action. Careful planning and monitoring cash value life insurance policies is the best course of action.Answered on November 13, 2013+0
Contact Peggy Mace Contact Peggy Mace by filling out the form below
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Cons Of Life Insurance Loans
Policy Loans Reduce the Death Benefit
The reduction in the death benefit due to policy loans is often not a major drawback as many cash benefit life insurance plans are designed to increase the death benefit over time. Thus, if you take out a loan the remaining death benefit may still provide acceptable coverage.
Also, you may not need as much death benefit coverage later in life, so you are OK with a decreased death benefit.
That being said, it still makes sense to carefully consider how any reduction in assets for your heirs caused by a loan would affect your estate planning before taking out a loan.
One way to deal with this is to fund Paid-Up Additions during loan repayment. These payments are allocated in the following manner: approximately 95% to cash value, with the remainder serving to incrementally boost the death benefit. Using PUAs is an effective method of increasing your available cash value while at the same time boosting the policys death benefit.
Interest Charged on Loans
If you dont pay back a loan, the interest being charged reduces your cash value. While the interest credited to your remaining cash value can offset the interest charged on the loan to some degree, if the loan isnt repaid after a long enough time there is a risk of policy cancellation. If this happens not only is the life insurance itself lost, but there can also be tax consequences.
Possible Tax Consequences
Emergency Fund Depletion