The following primer answers common questions about permanent life insurance policy loans and will help determine whether a policy loan is a good idea for you.
How Do Permanent Life Insurance Policy Loans Work?
Life insurance policies are typically divided into two main categories: term and permanent. Policyholders can only borrow against permanent life insurance policies. Term life insurance has no actual cash value and only provides insurance for a specific time period, normally anywhere from 5 to 30 years, and may not last the lifetime of the insured.
Permanent life insurance builds cash value over time and provides coverage upon the death of the policyholder, whenever that may take place, provided that the premiums are paid and the policy remains in force. The amount that can be borrowed from a permanent life policy is the surrender or loan value.
Do I Have to Pay It Back?
Because you’re borrowing against the cash value of your life insurance policy, there’s no actual requirement to pay back what you’ve borrowed. However, if you don’t pay the money back, be aware that you’ll lose that money from your death benefit. So if others are depending on your life insurance payout later in life, you’ll want to discuss repayment options with your insurance advisors.
While there’s no rule that says you must pay back the loan, another thing to keep in mind is that you could lose your policy if the cash surrender value is exceeded or equaled by the amount borrowed and interest associated with it.
Where Does the Money Come From?
Borrowed money comes out of your cash value, which is like a savings account in a permanent life policy. The rate at which the cash value builds and amount of time before it can be borrowed varies with each policy.
What Do I Need to Know About Interest?
Interest rates for permanent life insurance policy loans are typically competitive with traditional bank loans but feature more repayment flexibility.
Even though the loan disbursement itself is not taxed, interest payments on the loan are not tax deductible. Any unpaid interest is recapitalized on top of the loan balance; borrowers should make sure to keep up with their obligations as over time the accumulated interest can cut deeply into death benefits. Falling too far behind might even jeopardize the policy.
Little-Known Benefits of Permanent Life Insurance Policy Loans
Because a maturing permanent life insurance policy carries an actual cash value, the policyholder can access it for just about any reason without an extensive approval process.
There are fewer hoops to jump through and fewer regulations for the borrower versus, say, borrowing from a 401(k). No credit checks are required and payments have no bearing on credit score.
Life insurance companies are under strict regulation, which provides additional protection to the borrower.
Some mutual companies offer permanent life insurance policies that pay dividends, which are shares of company profits that go to policyholders. Dividends can be returned in a number of ways, including cash payments, premium reductions and coverage increases.