September is “Life Insurance Awareness Month,” and we wanted to answer this common question: “What life insurance can you borrow from?” Since life insurance policies come in many forms, let’s start with the type you can’t borrow from. The most common form of life insurance is called “term life.” Term is the simplest form of life insurance because it provides only a “death benefit” which is paid to a beneficiary upon the insured’s death during the coverage period.
You cannot borrow from a term life policy because it is designed to solely provide financial protection in the form of a death benefit. Term life insurance guarantees a certain death benefit payout if the insured dies within a specified period, such as 1, 2, 10, 15, or 30 years, after which the policy ends. Premiums for term insurance are often level for a certain number of years, though some policies may increase as the insured gets older depending on the design.
Life Insurance Policies You Can Borrow From
Permanent life insurance policies generally include a cash value component in addition to the death benefit. This cash value grows over time and may be available to borrow against under the terms of the policy.
Unlike term insurance, permanent policies are designed to remain in force for the lifetime of the insured, provided premiums are paid. The cash value in a permanent policy may be accessed during your lifetime—you can borrow it to help cover college costs, supplement retirement expenses, start a business, and more—sometimes with potential tax advantages, depending on your circumstances and as long as the policy remains in force.
Will I Owe Interest on Amounts I Borrow from a Life Policy?
If you borrow from the cash value, the loan is typically tax-free, but you will be charged a fixed or variable interest rate on the outstanding balance of any loan depending on your policy’s terms. It is important to review the terms carefully and consult with your financial professional to ensure the policy stays in good standing if you borrow from it.
Some policies may continue to credit interest on the full cash value, even if you have borrowed money. In certain cases, this credited interest may offset or exceed the loan interest but varies per policy. It is essential to understand all policy terms and conditions before making any decisions about borrowing against it; this is where good advice can help.
Permanent Types of Insurance You Can Borrow From
The types of permanent insurance policies that may build cash value are whole life, universal life, and variable life.
- Whole Life
Whole life insurance policies are permanent policies with fixed premiums that don’t go up and cash value accumulation guaranteed by the financial strength of the issuing insurance company.
- Universal Life
Universal life insurance gives consumers flexibility in premium payments, death benefit amounts, and the savings/cash-value elements of their policies, which is why it’s sometimes called adjustable life insurance. There are different types, including indexed universal life (IUL). With IUL policies, the cash value is linked to the performance of an index or indices, such as the S&P 500®, for potential growth. While the cash value growth is tied to index performance, the money is not actually invested in the market. IUL policies are generally subject to caps, participation rates, and sometimes spreads, which limit the amount of interest credited. Many policies also include a floor (often 0%), which can help protect against negative index returns. However, the policy’s cash value may still decline due to cost of insurance charges and expenses deducted. While the policy is shielded from direct stock market losses, its growth potential depends on the crediting terms outlined in the policy.
- Variable Life
Variable life insurance allows the cash-value portion to be invested in subaccounts, which are tied to the performance of the market and can fluctuate over time. As a result, there is potential for both growth and loss of principal. Variable life policies typically involve higher fees due to investment management. Policyholders receive prospectuses to help assess whether the subaccounts align with their overall risk strategy.
If I Borrow Money, What Happens to the Policy After I Die?
Many permanent life insurance policies can be purchased on a “joint survivorship” basis. There are two types: first-to-die, which pays out to the surviving spouse after the first dies; and second-to-die, or survivorship, which pays a death benefit to the heirs after both spouses are gone.
Whether joint survivorship or not, if you borrow cash value from a policy, the amount borrowed is generally deducted from the total death benefit paid to your named beneficiaries in addition to any remaining fees or interest owed. If you don’t borrow money, the cash value is added to the death benefit.
What Else You Should Know About Life Insurance
- The death benefit paid to your beneficiaries is generally income tax-free and bypasses probate, provided the policy’s beneficiary is an individual rather than a trust.
- Life insurance can be part of a comprehensive financial plan, supporting estate planning or leaving a tax-advantaged legacy to your loved ones.
- Most life insurance policies require a medical exam, and in cases of ill health, coverage may be denied, or the policy costs may be higher. Policies in force are typically not cancelable for changes in health as long as premiums are paid.
- Some policies offer living benefit provisions for chronic, critical, terminal illness, or long-term care benefits, which may be used in lieu of, or in addition to, the death benefit.
Each life policy from each different insurance carrier has different features, and the various product choices can be confusing for a consumer to navigate. Additionally, new types of policies are being introduced to the market all the time which may offer different terms. It is very important to work with a qualified professional to find the policy that may be best suited to meet your family’s needs. Call us to learn more about life insurance! You can reach Envisage Wealth Advisors by calling (859) 277-6528.
This article is for general information purposes only and is not to be relied upon for financial advice. In every case, you should seek the advice of qualified tax, financial, and legal professionals to ensure that a life policy is advisable based on your unique circumstances.
Guarantees are provided by insurance companies and are reliant upon the financial strength and claims-paying ability of each individual insurance carrier issuing a life insurance contract.
Life insurance requires medical underwriting; therefore, not everyone will be able to purchase a life insurance policy. Life insurance policies can be complex, and it is recommended that you work with a professional to examine policy terms.
Policy loans and withdrawals will reduce available cash value and the policy’s death benefit and may cause the policy to lapse. They may also have tax consequences if the policy terminates before repayment. Loans and withdrawals from life insurance policies that are classified as modified endowment contracts may be subject to tax at the time that the loan or withdrawal is taken and, if taken prior to age 59½, an additional 10 percent federal tax may apply.
Indexed universal life insurance policies are not direct stock market investments and are subject to caps, participation rates, spreads, and policy charges that may limit credited interest.
Variable life insurance policies are subject to market risk, including possible loss of principal. Prospectuses for variable life insurance should be read carefully before investing.
Sources:
https://www.iii.org/article/what-are-different-types-permanent-life-insurance-policies
https://www.investopedia.com/articles/pf/07/whole_universal.asp
