How Can I Get a Life Insurance Loan?

How Can I Get a Life Insurance Loan?
Written by Publishing Team

Can you borrow from life insurance? Yes. Must Borrow from life insurance? The answer depends on how much it costs to borrow versus life insurance.

In short, a policyholder who takes a loan under a life insurance policy and repays it quickly enough to avoid interest charges may be fine. But a policyholder who takes cash out of a life insurance policy without a plan may soon learn that life insurance loans can eventually be more expensive than expected.

Life insurance loans can be challenging – terms vary widely by company and policy type. When borrowing against life insurance, it is important to examine the downsides. For example, here are three of the financial consequences of borrowing from a life insurance policy:

1. Debt accumulation

The way interest works can be a bit tricky with a life insurance loan. Suppose the policy holder takes out a loan of $25,000 at an interest rate of 8%. The interest in the first year is up to $2,000. The policyholder can either pay $2,000 out of their pocket (with a down payment if they wish) or pay out $2,000 of the cash value left on their policy. If they choose to take the money out of the cash value, that amount will be added to their total debt, so they now owe $27,000. The following year, she owed $27,000 in interest, which adds another $2,160 to debt, etc.

There is a bit of “babysitting” that should continue once the policyholder borrows against life insurance, especially if it allows for increased interest. At some point, they may take more cash than they have on their policy, and the policy will expire. If the document lapses and is rescinded, they forfeit everything they paid for, no longer have the death benefit they leave to the heirs, and likely owe taxes on the money withdrawn.

2. Tax implications

As long as the policy is active, the money accumulated is not taxed. However, it is considered a taxable gain when the policy’s cashback value exceeds the premiums paid.

Here’s a simplified example: Let’s say someone is paying for a 20-year policy. They pay a total of $20,000 in premiums, and the cash value grows to $23,000. They borrow 85% of the cash value, or $19,550. They have reached a tricky point and stopped paying insurance premiums. Initially, the insurance company gets the remaining cash value of $3,450 to cover the premiums. Once that money is gone, they cancel the policy. Then the IRS says the policyholder owes taxes on the difference between the cash value that was in the account ($23,000) and the total premium payment over the years ($20,000), and sends them a $3,000 invoice.

3. Changes in death benefits

Any unpaid portion of a life insurance loan upon the policyholder’s death is deducted from the death benefit. For example, if someone dies because of their $60,000 debt on a $500,000 life insurance policy, the beneficiaries receive $440,000.

An interesting note about permanent life insurance and death benefits is that insurance companies “absorb” any accumulated cash value. Let’s say a person has a $500,000 policy that has collected $50,000 in cash value. When they die, their beneficiaries receive $500,000, but the insurance company gets $50,000. The only solution is if the insured buys a special rider that gives the cash value of the estate.

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