The Pros and Cons of Borrowing From Your Life Insurance
June 01, 2022
If you’ve considered borrowing against your life insurance policy to generate some cash, you may have some questions about how the process works and whether it’s even worth it. There are many reasons you might choose to borrow from your life insurance over getting a bank or credit loan. Of course, you’ll want to study up about how these unique loans operate to avoid any unexpected consequences. This guide will walk you through the primary pros and cons so you can be better informed before deciding what’s right for you.
Can you borrow from life insurance?
If you have permanent life insurance (whole life or universal life) that has accumulated cash value, the simple answer to this question is yes and it’s generally an easy process. Your life insurance policy is an asset that you already own, so there is no need to go through an approval or application process. However, it is important to remember that a loan against your life insurance policy is not technically borrowing from yourself. You are still borrowing from the life insurance company, using the cash value of your policy as collateral.
- Simplified loan process – There is no application or qualification process. A loan against your life insurance policy won’t show on a credit report.
- Generally lower interest rates and closing costs – When compared with a bank loan, you’ll likely receive a better interest rate and avoid those high closing costs.
- Receive funds quickly – Depending on your company, you could receive a check in a matter of days.
- No restrictions on how to use your funds – Your insurance company does not need a description of how you intend to use this money in order to complete the loan.
- Flexible payback schedule – Unlike other types of loans, you can often create and modify your own repayment plan as suits your needs. However, it is important to note that interest will accrue whether you make frequent payments or not.
- Often tax-free – You should always consult a tax professional to be sure, but in most cases a loan against your life insurance policy will not be considered additional income and will not be recognized by the IRS as taxable. Of course, there are a few unique scenarios that may incur taxation.
- Potential for policy lapse or tax consequences – Unpaid interest exceeding the cash value could cause the policy to lapse, or for the insurance company to terminate the loan altogether. If this were to happen, the IRS may recognize the loan balance and interest as taxable income.
- Reduction of death benefits – If you were to pass on while still owing money on your loan, that balance plus any interest accrued would be repaid from the death benefit. This could result in no benefits or significantly lower benefits for your beneficiaries
- Depleting emergency funds – Many use the cash value of a life insurance policy as a safety net, should they suddenly be unable to meet the premium payments. As mentioned previously, borrowing over the cash value amount could result in the loss of the policy.
- Cash value needs time to build – In order to use the cash value as collateral, you will need to have paid into the life insurance policy over at least a few years. Early on in your policy, you may have accrued little value to borrow against.
While borrowing from your life insurance policy can be advantageous, you should only do so when you’re confident you’ll be able to repay the loan.
Keep in mind, borrowing and loans are not the only way to generate income out of your life insurance policy. If you no longer need the policy or can no longer afford the premiums, a life settlement could result in more than the policy’s cash value. Contact Lighthouse Life or read through the Pros and Cons of Life Settlements for more information.