How to Borrow Against Your Life Insurance Policy: What You Need to Know First

You’ve probably heard someone say you can borrow money from your life insurance while you’re still alive. That’s true with some policies, but there’s a lot more to the story.

You can’t buy an inexpensive term policy today and call the insurance company tomorrow asking to borrow $50,000. That’s not how life insurance loans work.

Policy loans can potentially provide access to cash, but they’re not free money. Loans generally accrue interest, can affect the amount your beneficiaries receive, and, if poorly managed, may even contribute to a policy lapsing.

Can You Borrow Against Any Life Insurance Policy?

No. The ability to take a policy loan is generally associated with permanent life insurance policies that accumulate cash value.

Depending on the contract, this can include certain whole life, universal life and indexed universal life policies.

Term life insurance generally doesn’t build cash value. If you own a $500,000 term life policy, that does not mean you have $500,000 sitting somewhere waiting for you to borrow.

If you’re still learning about the basic differences, read our guide to term vs. whole life insurance.

What Is Cash Value?

Cash value is a feature available with certain permanent life insurance policies. How it develops depends heavily on the type of policy and its contract.

Whole life policies typically include guaranteed cash-value provisions, while participating policies may also pay dividends, although dividends are not guaranteed.

Universal life policies work differently. Their policy values can be affected by premiums, credited interest, insurance costs and other policy charges.

Indexed universal life insurance is different again. Interest may be credited based partly on the performance of a market index, subject to the policy’s specific crediting provisions. These may include participation rates, caps, spreads and floors.

How Does Borrowing Against Life Insurance Work?

When you take a policy loan, you’re generally borrowing money from the insurance company with your policy’s value helping secure the loan.

That distinction matters because a policy loan isn’t necessarily the same as simply withdrawing your cash value.

Do You Have to Pay a Life Insurance Loan Back?

Many policy loans don’t operate like a traditional bank loan with a fixed monthly repayment schedule. However, that should never be confused with the loan being free.

Interest generally accrues on the outstanding loan. If you don’t repay the principal or manage the interest, the balance can continue growing.

An outstanding loan can also reduce the amount ultimately paid to your beneficiaries.

Can a Policy Loan Reduce Your Death Benefit?

Yes. This is one of the biggest things people overlook when they hear about borrowing against life insurance online.

Imagine that a policy provides a $250,000 death benefit but has an outstanding policy loan when the insured dies. The insurer can generally deduct the outstanding loan and applicable interest from the amount otherwise payable under the policy.

That’s why borrowing against a policy should be viewed as a financial decision, not simply a source of money with no consequences.

Why Do People Borrow Against Life Insurance?

Policyholders may use policy loans for many purposes, including emergencies, business expenses, education, major purchases or temporary cash-flow needs.

Because the loan is secured by policy value, a traditional credit approval process may not apply in the same way it would with an unsecured bank loan.

However, easy access doesn’t automatically mean borrowing is the right decision.

Are Life Insurance Policy Loans Tax-Free?

This subject deserves some caution.

Policy loans generally aren’t treated as taxable income when taken under certain circumstances from a properly structured policy that remains in force. But that does not mean every policy loan is automatically tax-free forever.

If a policy with gain is surrendered or lapses while a loan is outstanding, tax consequences can potentially arise. Modified Endowment Contracts, commonly called MECs, also have different tax rules regarding distributions and loans.

The IRS explains that life insurance proceeds and distributions can receive different tax treatment depending on the circumstances. See the IRS guidance on life insurance proceeds.

Policy Loan vs. Withdrawal: They’re Not the Same

A withdrawal, sometimes called a partial surrender, generally removes value from the policy.

A policy loan generally involves borrowing from the insurer with policy value serving as collateral.

Those transactions can affect your cash value, death benefit and taxes differently. So when someone says they’re “taking money out of their life insurance,” it’s important to determine whether they’re talking about a withdrawal or a loan.

What Is the Biggest Risk of Borrowing Too Much?

One of the most serious risks is a potential policy lapse.

Imagine borrowing heavily against a policy and allowing the loan interest to continue accumulating. If the remaining policy value eventually becomes insufficient to support policy charges, the coverage could potentially lapse.

That can be especially serious because you could lose the insurance protection and, depending on the circumstances, potentially face tax consequences.

For universal life and indexed universal life policies, it’s particularly important to understand how loans interact with policy charges and future crediting.

If you own an IUL or are considering one, read our guide to the different types of life insurance before assuming every permanent policy works the same way.

What Does “Be Your Own Bank” Really Mean?

You may have seen whole life, indexed universal life or “infinite banking” content online describing life insurance as a way to become your own bank.

Life insurance doesn’t literally turn someone into a bank. The phrase generally refers to strategies involving accumulated policy value and policy loans.

Those strategies can involve real costs. Life insurance premiums cost money, policy loans charge interest, cash value may take time to accumulate, and certain policies can have surrender charges and other expenses.

How Soon Can You Borrow Against Life Insurance?

There isn’t one universal waiting period.

The policy first needs sufficient available cash value. How quickly meaningful value develops depends on the type of policy, premium funding, policy design, charges, guarantees and, where applicable, policy performance.

A newly issued policy may have very little available cash value during its early years.

How Much Can You Borrow?

The maximum loan amount depends on your specific policy and insurer.

Don’t assume you can borrow every dollar shown as cash value. Your insurance company can tell you the actual amount currently available for a policy loan.

Ask These Questions Before Taking a Policy Loan

Should You Borrow Against Your Life Insurance?

A policy loan isn’t automatically good or bad. It depends on the policy, the reason you’re borrowing, the loan provisions and how you plan to manage the loan afterward.

Be particularly cautious if the loan could put your coverage at risk, you don’t understand the loan terms, or you’re borrowing simply because the money happens to be available.

Remember why you purchased life insurance in the first place. If excessive borrowing ultimately destroys coverage your family was depending on, the strategy has worked against the policy’s primary purpose.

The National Association of Insurance Commissioners also provides consumer information about life insurance, including permanent coverage and cash value.

Frequently Asked Questions