Borrowing From a Universal Life Insurance Policy: What You Need to Know

Can You Borrow From a Universal Life Insurance Policy?

Yes, most universal life policies allow policyholders to take out a loan against the cash value accumulated in the account. The loan is a tax‑free borrowing opportunity, but it is subject to interest and repayment terms set by the insurer.

How the Loan Mechanism Works

A universal life policy builds cash value through the portion of premiums that exceed the cost of insurance. The insurer treats this cash value as collateral. When you request a loan, the company credits the amount to your policy and begins accruing interest. The loan is typically secured at a rate that is a fixed percentage above a benchmark, such as the prime rate or the Treasury yield.

Interest, Repayment, and Default

Interest accrues continuously, and if left unpaid, it is added to the loan balance. The policyholder may choose to repay the loan voluntarily or allow the insurer to automatically deduct payments from future premiums. If the loan balance plus accrued interest exceeds the policy's cash value, the policy lapses, and the death benefit may be reduced accordingly. In most cases, the insurer will not require repayment until the policyholder dies or the policy is surrendered.

Impact on Death Benefit and Policy Value

While the loan itself does not immediately diminish the death benefit, the unpaid loan balance and accrued interest are subtracted from the benefit at the time of death. For example, a $200,000 death benefit with a $50,000 outstanding loan will leave the beneficiary with $150,000. Additionally, a high loan balance can reduce the policy's cash value, limiting future borrowing capacity or the ability to roll over premiums.

Key Considerations Before Borrowing

• Interest Rate Risk: Rates can rise, increasing the cost of borrowing.
• Policy Lapse Risk: Large loans relative to cash value can trigger lapse.
• Tax Implications: While loans are tax‑free, a policy that lapses with an outstanding loan may trigger a taxable event.
• Long‑Term Cost: Accrued interest can erode the policy's value over time.

Alternatives to Policy Loans

Consider other financing options such as personal loans or lines of credit, especially if the policy's cash value is low or if the interest rate on the policy loan is high. A financial advisor can help assess whether borrowing from the policy aligns with your overall financial strategy.