How to Borrow Against Your Life Insurance Policy: A Comprehensive Guide
Life insurance policies, particularly permanent life insurance such as Whole Life, Universal, and Variable Universal, come with additional features like the ability to borrow money from your feature is incredibly handy in times of need, but it's important to understand the terms and implications thoroughly.
Determining Whether Your Policy Qualifies as a Loan Source
Not all life insurance policies allow you to borrow against them. To find out if your policy allows it, you need to understand the type of policy you own. The most common types of life insurance policies are:
Permanent Life Policies
Whole Life Insurance: This type requires you to pay a fixed premium for a specific period, and it builds cash value over time.Universal Life Insurance (or Variable Universal Life Insurance): Your premium pays for insurance coverage and part of it is invested in separate accounts. The cash value grows based on the performance of the investments.Term Life Insurance
Term Life Insurance: This provides coverage for a specific term (usually 10, 20, or 30 years), and does not build cash value.Notably, you can only borrow from a permanent life insurance policy. The owner of the policy can avail of this feature, and it's not available to the insured or beneficiaries unless they also are the owner.
Deciding Whether to Take the Loan
Considering the benefits of a life insurance loan versus a conventional loan can help you decide if taking out a policy loan is the right choice for you. Here are some pros:
No credit check or income verification required since you're borrowing from yourself.Lower interest rates than traditional bank monthly payment or repayment period; the balance is deducted from the death benefit to your beneficiaries.However, there are downsides to consider as well. These include:
Unpaid interest will accrue and compound, potentially increasing the loan balance.Dividends generated by the insurance policy may decrease, as less of your premium is available for cash value in your policy is often protected from creditors, but once you withdraw money, the amount is no longer shielded.If the loan balance exceeds the policy's cash value, the policy could lapse, and you'd need to pay back the full loan in one lump sum.Tax-wise, the loan proceeds are generally not taxable as long as the loan amount is equal to or less than the total premiums you've paid. However, if the policy lapses, the IRS may consider the loan balance plus interest as taxable income.
Requesting the Loan
Follow these steps to request a loan from your life insurance policy:
Get the form: Contact your insurance company to obtain the necessary form. You might also be able to download it from the company’s website. Some insurers permit phone arrangements for loans below a certain amount, such as 25,000. Proper Identification: Ensure you've provided all necessary information, including the owner of the policy. If it involves a trust, you'll need the trust's date of being established, the owner’s contact information, and their social security or tax ID number. Determine the Payout Method: The loan application will ask how you want the proceeds distributed. You can choose to have the proceeds paid by check or apply the loan directly to future premium payments. Keep Track of the Loan: Monitor the loan balance regularly compared to your policy's cash value. Devise a disciplined repayment plan, and make regular scheduled payments to prevent the loan from increasing and to avoid lapsing the policy. Remember to pay the interest on the loan annually to avoid further increases.Borrowing against your life insurance is a smart financial move, especially if it helps pay off debts, covers emergency expenses, or funds retirement savings. However, understanding the implications thoroughly is crucial to ensure it aligns with your financial goals and long-term strategy.