Permanent life insurance policies with sufficient cash value normally allow loans to be taken out. This wonderful “living benefit” of a life insurance policy can be accessed at any time, and for any reason. A person can normally borrow up to about 90% of the current cash value in the form of a loan.
Types Of Life Insurance That Allow Loans
Any life insurance policy that has cash value will allow a loan to be taken against that value under normal circumstances (assuming sufficient cash value exists to meet minimum loan requirements). This means that whole life, universal life, and variable universal life insurance contracts all allow loans to be taken out.
The type of life insurance that does not allow a loan to be taken out is term life insurance. Term life insurance has no cash value, and therefore it is impossible to loan against this product type. Term insurance does not build cash value because it is not a permanent form of life insurance, and it would be unnecessary to have an accruing value as this would add unnecessary additions to premium payments.
Life Insurance Loans Have Interest
A loan from a life insurance policy does accrue interest. This rate of interest varies between companies and products, and you should always check with your life insurance provider before you request a loan. While the loan is from your own policy value, the accrued interest goes directly to the insurance company. If you can avoid taking a loan you should, but there are some distinct advantages of using a loan over a withdrawal if you need to access your policies value.
Advantages Of Loans
- The biggest benefit a loan provides is the ability to access value from your policy during a time of need. This can be used for any purpose, such as during a financial hardship due to unemployment, unexpected expenses, the purchase of a new car, a down payment on a house, or even for a vacation. There are no restrictions with what can be done with a loan from a life insurance policy.
- A loan does not permanently reduce the death benefit of a policy. If a loan exists at the time of a death claim, the amount of the loan is deducted from the death benefit payout. A withdrawal from a life insurance policy may permanently reduce the face amount of the contract.
- A loan is not taxable unless the policy is a modified endowment contract (MEC), or if the loan defaults, and at that point it may or may not be taxable.
- The value of the loan may earn interest in a collateral loan account within the policy, and this reduces the effective interest rate on the loan.
- Loans from life insurance policies have flexible repayment options. See below.
Disadvantages Of Loans
- Loans are charged interest, which go straight in the insurance company’s pocket. They may also reduce dividend payments in a whole life policy or reduce the potential for higher market returns in a variable policy. A loan will cost a policy owner money from their policy value in most all cases.
- If a loan gets too large, the rate of interest accruing plus the premium payments due may become too large for a policy owner to keep up with. This can cause a policy to lapse and the insured person to lose valuable coverage.
- Loans reduce the death benefit by the amount of the outstanding loan at the time of death.
Repaying A Life Insurance Loan
Life insurance loans can be paid off at a policy owners will. There is no set repayment schedule, but insurance companies may send a bill for the interest accrued, or may allow you to set up a repayment schedule. A loan will not default unless there is no additional cash value in a life insurance policy to add to the loan. An unpaid loan will grow by the amount of interest accrued. At Life Ant we recommend in most cases that if you take a loan from a life insurance policy, you direct future payments to go toward loan repayment if possible to pay the loan down as quickly as possible.
Loans are a nice feature of life insurance policies, and allow easy access to liquid cash for policy owners. This is why life insurance policies make nice savings tools.