What Happens If You Borrow From Your Life Insurance Policy?

Deciding which life insurance policy is best for you and your loved ones can be difficult. There are several different policy types to choose from. All of them have different advantages and disadvantages that you have to weigh. Each household is different, which means that everyone has varying life insurance preferences.

Today, there are numerous types of life insurance such as whole life, universal life, and variable life, that offer either a cash value or investment component – and along with this feature also comes the ability to borrow funds from the policy. Deciding which life insurance policy is best for you and your loved ones can be difficult. There are several different policy types to choose from. All of them have different advantages and disadvantages that you have to weigh. Each household is different, which means that everyone has varying life insurance preferences.

Perhaps you are thinking you may not qualify for insurance due to health conditions. If so, we can help you find the best life insurance without a medical exam, so don’t let anything stop you from getting the coverage you deserve.

In most cases, even the guaranteed interest rate that is offered on a whole life insurance policy is higher than the rates on bank savings and money market accounts. These life insurance cash value funds are also allowed to grow tax deferred, meaning that no tax is due on the gain until the time the funds are withdrawn. Because of this, these funds will typically end up growing at a much faster pace in comparison – and therefore, they can provide the policyholder with a nice amount of money over time.  You should know that the primary type of life insurance that does not allow for loans is term life insurance.  This is because the policy does not accrue a cash values, and thus, there is nothing to borrow against. The advantage to term policies though, is that they are cheapest because they don’t accumulate cash value. You’ll need to decide which is more beneficial for you and your loved ones.

Why Borrow From Your Life Insurance Policy?

There are many reasons why someone would want to borrow funds from their life insurance policy. First, in many instances, the borrowed funds can be tax free – provided that they are repaid within a timely manner and before the insured passes away.

In addition, unlike taking funds from an IRA (Individual Retirement Account) or a 401(k) retirement account, there are no IRS (Internal Revenue Service) “early withdrawal” type penalties for taking funds out prior to attaining a certain age.

In most cases, policyholders are allowed to borrow up to 90% of their cash value – and in some instances, the entire amount is available to them. Oftentimes, these funds are also available for borrowing at a very low rate of interest. Yet, although it may seem tempting to obtain such a low interest loan, there are a number of important factors to keep in mind before doing so.

Taxes on Policy Loans

One consideration when taking out a life insurance policy loan is taxes. Although a life insurance policy loan is not considered to be a taxable distribution or income – because it is required to be repaid with interest – should the policyholder fail to repay the loan, he or she may have some tax repercussions.

In this instance, the remaining cash value in the policy may need to be used for repaying the loan. If this were to happen, then the amount that is paid would be considered income, and would therefore be taxable as such.

In addition, if the policy were to end up lapsing due to borrowing too much, the policy loan would then be considered as being “forgiven” by the IRS (Internal Revenue Service). In this case, the loan would not be required to be repaid. It would, however, then be considered as ordinary income and be subject to income tax to the policyholder.

It is important to be especially careful in this case because, depending on the amount of a loan that is forgiven, it could actually place a policy holder into a higher income bracket altogether, increasing their overall income tax rate as well.

The Effect on the Death Benefit

Borrowing from a cash value life insurance policy can also have implications on the death benefit as well. In this case, if the loan has not been repaid and the insured passes away, the death benefit proceeds will be minus the amount of the unpaid loan balance.

Depending on the amount of the unpaid loan, this could have substantial consequences on beneficiaries who were counting on the proceeds for paying final expenses, paying off debt, reducing estate taxes, or paying their ongoing living expenses.

On top of this, there are some life insurance companies that could also require certain administrative fees or other related costs to policyholders for taking out policy loans. If this is the case, these expenses should be factored in – along with the interest rate on the loan – in order to come up with the total cost of borrowing the funds.

Borrowing on your life insurance policy is an excellent safety net to have in case you ever need it. But it’s not something that you should do lightly. There are a lot of different factors that you have to consider. You don’t want to make any decisions that you negatively impact yourself or your family’s finances.

The Bottom Line

While it is possible to borrow from your life insurance policy, doing so can definitely have certain financial consequences if you are not careful with regard to repaying the loan within certain parameters. With this in mind, however, borrowing from a cash value policy can provide you with a way to obtain a low interest and penalty free loan.

If you’re interested in obtaining quotes on cash value life insurance, we can help you find the best policy for your particular needs. We work with many of the best life insurers in the marketplace and can get you quotes quickly and easily by filling out the form on this page to get the process started.

We work with some of the most highly rated insurance companies across the United States, and we can bring all of the lowest insurance rates to you. Don’t waste your time calling dozens of agents to find the best rates. Let us save you time and money.

Life insurance is the most important investment that you’ll make for the future of your family. It’s the best way to ensure that they will be taken care of if something tragic were to happen to you. You don’t know what’s going to happen tomorrow, don’t’ wait any longer to get the life insurance protection that they deserve.

If you have any additional questions regarding life insurance policy loans, comparing policy quotes, or even about life insurance in general, please feel free to give us a call at 334-380-4188 and we will be happy to help.