Borrowing from a Life Insurance Policy: How It Works and When It Makes Sense

What Is a Policy Loan?

A policy loan is a way to tap the cash value built into a permanent life insurance policy, such as whole or universal life. The insurer lends you money, typically up to 80% of the policy's cash value, and you repay it with interest. If you don't repay, the outstanding balance is deducted from the death benefit.

Key Features of Policy Loans

• Tax‑free borrowing: Loans are not taxable as long as the policy stays in force.
• Interest rates: Usually set by the insurer, often below market rates, but they compound if unpaid.
• No credit check: Availability depends on the policy's cash value, not your credit history.
• Repayment flexibility: You can repay anytime, or let the loan remain unpaid if you prefer.

When Borrowing Makes Sense

Policy loans can be useful for short‑term liquidity needs—covering a home renovation, consolidating high‑interest debt, or bridging cash flow during a business transition. They also serve as a low‑risk source of funds for retirees who want to avoid dipping into taxable investments.

Potential Downsides to Consider

Unpaid loans reduce the death benefit and can trigger policy surrender if the cash value falls below the loan balance plus fees. Excessive borrowing may also cause the policy to lapse if the insurer's required minimum equity is breached.

Tax Implications and Lapse Risk

While the loan itself is not taxed, the interest paid is not deductible. If the policy lapses, the loan balance becomes taxable income, and you may owe a penalty for early withdrawal.

Comparing Policy Loans to Other Credit Options

Best Practices for Managing a Policy Loan

• Track the loan balance and interest in your policy statements.
• Set a repayment plan that aligns with your cash flow.
• Monitor the policy's equity to avoid lapse risk.
• Consult a financial advisor to assess the impact on your estate plan.