Life insurance policies that have ‘cash value’ can be borrowed against. These policies are structured so that a portion of monthly premiums are invested in financial instruments which build value over time. The amount of money in your cash value account will depend on 1) previous loans and their repayment, 2) length of contributions, 3) types of financial instruments invested in, and 3) net cash value. Some useful considerations regarding insurance loans are pointed out below:
* You can borrow up to the full amount of your cash value
* Loans are not taxable so long as the amount borrowed is covered by the policy
* Paying back loans on life insurance is optional
* The cost of an insurance loan is determined by your insurer
* Cash value remains in the insurance policy remains
* Cash surrender value i.e. available cash, of the policy is reduced with the loan
Section I: Steps to take when borrowing against life insurance
The terms of life insurance companies specify exactly if and how much you can borrow from your life insurance. The best source of information regarding what you can or can’t do is your insurance policy itself. That said, borrowing against your life insurance involves a few steps that can make the process seem clearer.
i) Determine cash value: The first step in borrowing against a life insurance policy is to determine if it has cash value. Cash value policies can all be borrowed against and exclude term life insurance which does not accumulate cash value. Your insurance cash value can be found on your most recent policy statement.
ii) Read your insurance policy. Reading your insurance policy will help you determine what is involved in the loan, the terms of agreement, any fees, surcharges or otherwise unknown information associated with the loan.
iii) Call your insurance agent: After you have become familiar with the loan process, call your life insurance agent to inquire about borrowing against the cash value of your loan. What your insurance agent says should match the information in your policy.
iv) Fill out required forms: Borrowing against your life insurance may require you to fill out paperwork or online forms. These forms confirm you understand the terms of the loan and waives the insurance company of liability associated with non-agreement of terms.
Section II: Additional life insurance loan information
As with many other types of loans, the quicker a life insurance loan is paid back, the less interest will be paid which saves you money. If a life insurance loan is not repaid, the amount of the loan may be deducted from the death benefit in addition to the cash surrender value of the policy. In other words, you will be penalized for not paying the loan back, but it is not obligatory.
Taking a life insurance loan may increase the amount of your monthly premium if the interest from the loan is not completely offset by the earnings from the life insurance policy. Conversely, if your insurance investments consistently earn enough to pay for premiums and interest, and you participate in a premium offset plan that includes loan interest, then no interest will be due if it is covered by the plan.
Two benefits of life insurance loans are that 1) the loan is often not taxable and 2) the interest rates may be competitive. These benefits can partially or completely offset the fees paid to insurance companies for the policy. Thus, if you anticipate the need to make loans in the future, having a cash value insurance policy does have some advantages in comparison to other sources of financing.
Borrowing against life insurance requires you to have a cash value insurance policy such as universal life or whole life insurance. The amount of the loan available is determined by the cash value of the policy. Interest and borrowing terms are specified by the insurance company’s policy and/or terms of agreement and insurance contract. Premiums may increase or the insurance policy may be cancelled if the income bearing instruments within the insurance policy cannot match or surpass the required loan and insurance costs.
There are some benefits to insurance loans such as not having to pay them back, tax-free financing, and lower interest rates. However, if the loan is not repaid, the death benefit of the policy may be reduced along with cash surrender value. This can increase the cost of insurance if a new policy has to be established. It is important to read the specifics of the loan and contact your life insurance agent directly so as to be informed of insurance company and policy specific information regarding borrowing from your life insurance policy.