Can You Take Out a Loan Against a Variable Life Insurance Policy?
Written By Cameron McDowell
Dec 14, 2021
5 mins read
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Variable Life Insurance Policy Loans: Understanding The Pros And Cons
Borrowing money from your variable life insurance policy is a simple way to get cash. It’s faster compared to taking out a loan from a bank and the requirements are also more lenient.
In this guide, we’ll talk about how policy loans work. We’ll also share the pros and cons of borrowing from your life insurance policy.
What Types Of Life Insurance Can You Borrow From?
Life insurance policies can be divided into two categories: permanent and term life insurance. The former provides coverage for the rest of the insured person’s life, provided that premiums are paid. The latter offers insurance coverage for a certain period, typically from 1 to 30 years.
You can take out a loan against permanent policies. Part of the premiums you pay for these permanent life policies is used to support the policy’s death benefit while another part goes to a cash-value account. The life insurance company invests money from the cash-value account in different ways, depending on the type of policy you own.
In the case of a variable life insurance policy, the cash value is deposited in several sub-accounts. Much like mutual funds, these sub-accounts can grow at varying rates. Once the cash value grows to a certain amount, then you can take out a loan against the policy.
Keep in mind that you cannot borrow money from term life insurance because it does not accumulate cash value.
How A Policy Loan Works
Taking out a policy loan means borrowing against your policy’s cash value. In most cases, you’ll be allowed to withdraw up to about 90% of the policy’s cash value, which you should pay back with interest.
It usually takes 5 to 10 years for the cash value to grow and accumulate. So, even if you have an active variable life insurance policy, you might still not be allowed to borrow money from it because of its low cash value.
Once you’ve determined that you’re eligible to borrow from your policy, you can start the loan application process. Just fill out a form from your insurer and you’ll see the money deposited in your account in a matter of days.
Unlike borrowing from a bank, you can pay back as little or as much as you want at any time. However, keep in mind that the loan amount accumulates interest if you don’t pay it back as soon as possible. That means you could end up paying interest on your loan’s interest.
As a rule of thumb, it’s good to borrow an amount that’s significantly less than the total cash value. You should also have the means to pay back the interest and the loan value within a reasonable amount of time.
Speak to your life insurance agent to learn more. You can usually ask them for an in-force illustration, which will give you all the details on what will happen if you take out a loan against your policy.
Benefits Of Getting A Policy Loan
Under the right circumstances, taking out a policy loan can be highly beneficial. Here are some of the reasons you should consider borrowing money from your variable life insurance policy:
There’s no approval process or credit check involved when it comes to borrowing from your life insurance policy. So, even if you have a poor credit rating, you won’t be turned away. Since the money you’re borrowing comes from your life insurance’s cash value, you’re essentially just borrowing money from yourself.
The US Internal Revenue Service doesn’t recognize policy loans as income. So, the money you gain from the loan shouldn’t be added to your taxable income for the year.
Low Interest Rates
Just like a typical loan, a policy loan should be paid back with interest. However, the interest rates are usually lower compared to borrowing from a bank or paying with your credit card.
Taking out a policy loan also comes with some major risks. Here are some of the issues you should be aware of:
Most people purchase a life insurance policy for the death benefit. However, if you take out a policy loan and don’t pay it back before you die, the loan amount plus interest will be subtracted from the policy’s face value. This reduces the amount of money your beneficiaries will receive upon your death.
While you’re not required to pay back your loan immediately, the life insurance company will compound interest the longer you wait. If the loan accrues a large enough interest that it exceeds your policy’s cash value, then it could cause your policy to lapse or terminate.
When this happens, you will lose your insurance coverage. You’ll also be required to pay income taxes if the outstanding loan amount is greater than the amount of money you’ve paid in premiums.
Taking out a loan against your variable life insurance policy can be a good option if you’re short on cash. However, make sure you understand how the loan will affect the cash value of your policy and what will happen if you don’t pay it back in a timely manner.
If you want to learn more about life insurance policy loans, get in touch with Wesley Insurance, LLC. We will help you understand the loan terms and conditions so you can see if this is the best option for you.