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August 15, 2020

How Do Life Insurance Loans Work?

life insurance loans

Life insurance is a must for virtually everyone. It can help your loved ones continue their way of life after you pass, and has helped people keep their homes, send their kids to college, and pay for funeral and other expenses during their darkest times.

Beyond a death benefit, many life insurance policies can also be used as a vehicle to plan for future costly life events like buying a home or paying for your children's college. These are known as cash value life insurance policies, and after the cash value has accrued, the owner may wish to borrow money from it.

Types of Cash Value Life Insurance

Typically, permanent life insurance builds cash value, while term life insurance does not, though there are exceptions. It’s important you understand the benefits and limitations of your life insurance policy, and know whether it has a cash value component.

How Cash Value Life Insurance Works

The cash value of your life insurance policy builds when you pay your premium. A portion of your premium will go toward the cost of insuring you, a portion will go toward the cash value, and a portion toward expense charges.1

There are several different types of cash value life insurance, and they all accrue cash value differently. Whole life insurance cash value accumulates at a minimum guaranteed rate; universal life insurance cash value is tied to an index like the S&P 500 or sub-accounts with investments you choose; and for guaranteed issue life insurance policies that have cash value, the value is typically small.1

Cash Value Life Insurance Loans

After you have accrued enough cash value, you may wish to take out a loan (depending on eligibility requirements). You can choose what you use that money for, and you can choose when you pay the loan back. Any amount not repaid may be deducted from the death benefit.

The loan amount you take may accrue interest until it is fully paid back.1

It’s important to note that if the balance of the loan becomes larger than the cash value (known as an over-loan), you must pay enough back to make the loan balance smaller than the cash value, otherwise you risk your policy lapsing.

What Else Should I Know About Taking a Loan from My Cash Value Life Insurance Policy?

There are several advantages of a life insurance policy loan. Depending on the insurance carrier, there may be no credit check and interest rates may be low.2 Disadvantages include the fact that funds may not yet be available if the cash value has not yet accrued, the death benefit will be reduced if the loan is not paid back, and the risk of over-loan and possible tax consequences if the policy lapses before your loan is repaid.

Be sure you understand how your cash value life insurance policy works, the rate at which it accrues cash value, how taking a loan against the cash value works, and your policy’s benefits and limitations.

If you have any questions, contact a financial advisor or a licensed insurance agent.

  1. Forbes, What to Know About Cash Value Life Insurance, 2020
  2. NerdWallet, When to Borrow Against Your Life Insurance Policy, 2017

Categories: Insurance, Life Insurance, Whole Life Insurance

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