Insurance You Can Borrow From Explained
Life insurance can do more than pay a death benefit. Certain permanent life insurance policies build cash value you can tap into while you’re alive. Borrowing from that cash value is a flexible way to access money — for a home down payment, college costs, a bridge loan, or even retirement income. But policy loans come with rules, costs, and implications for your death benefit and tax situation. This article explains how insurance you can borrow from works, which policies allow loans, realistic examples with numbers, the pros and cons, and the practical steps to take if you decide to borrow.
How life insurance policy loans work
When you buy a whole life, universal life, or another permanent policy, part of the premium goes into a cash-value account. Over time, the cash value typically grows from a combination of guaranteed interest crediting, dividends (in participating whole life), or market-based gains (in variable or indexed policies). The insurer uses those accumulated funds as collateral and lets you borrow against them.
Policy loans are different from withdrawals and different from borrowing against a bank account or a home equity line of credit. Here are the core mechanics in simple terms:
- Loan source: The insurance company lends you money using your policy’s cash value as collateral. You’re borrowing from the insurer’s general account, secured by your cash value.
- Interest rate: Insurers charge interest on loans. Rates vary by company and policy — often fixed or tied to an index. Typical loan rates range from about 3% to 8% depending on policy and market conditions.
- Repayment flexibility: You usually set the repayment schedule. You can pay it back on your timetable, but unpaid interest accrues and adds to the loan balance.
- Effect on death benefit: Outstanding loan balance plus accrued interest is subtracted from the death benefit if not repaid before the insured’s death.
- Tax treatment: Loans are generally not taxable while the policy remains in force. However, if the policy lapses with an outstanding loan, the loan may be treated as a distribution and become taxable to the extent it exceeds your cost basis.
- Lapse risk: Large unpaid loans that push the cash value below required levels can cause the policy to lapse, potentially creating a taxable event and loss of coverage.
In short: you can access cash without formally cashing in the policy, but borrowing has consequences that need attention.
Which policies let you borrow? How they differ
Not every life insurance policy allows loans. Short-term term life insurance (level term, 10/20/30-year term) generally has no cash value and therefore no loan feature. Only permanent policies — whole life, universal life (UL), indexed UL, variable life — build cash value and permit loans.
The table below summarizes common permanent policy types, whether they permit loans, typical interest characteristics, and pros/cons at a glance.
| Policy Type | Loan Allowed? | Typical Loan Rate | How Interest Works | Key Advantage | Key Risk |
|---|---|---|---|---|---|
| Whole Life (participating) | Yes | 3.0% – 6.0% (company-dependent) | Fixed or declared; dividends may offset interest | Stable guarantees; predictable cash value | Lower early cash value growth vs. some UL policies |
| Universal Life (traditional) | Yes | 3.5% – 7.0% (may be indexed) | Rates often tied to current crediting rates | Flexible premiums and death benefit options | Higher lapse risk if performance drops |
| Indexed Universal Life (IUL) | Yes | 3.0% – 8.0% (varies) | Loan rate may be fixed; cash value growth tied to index | Upside potential from market indexes with downside protection | Complexity and cap/participation limits |
| Variable Life | Yes | 4.0% – 8.0% | Loan interest separate from investment performance | Potential for higher growth through subaccounts | Investment risk; possible losses in cash value |
Each insurer sets loan-pricing rules. For example, one company might charge a guaranteed loan rate of 4% on whole life loans, while another charges 5% for outstanding balances under 10 years and then resets. Variable and indexed policies add another layer because cash value itself can fluctuate, affecting how much you can borrow and the policy’s safety margin.
A realistic example: policy loan math and outcomes
Seeing numbers makes this concrete. Below is a realistic scenario showing how a policy loan affects cash value and death benefit over time. We’ll use round numbers and a simplified approach to illustrate common outcomes.
Assumptions:
- Policy type: Participating whole life
- Current cash value: $120,000 (after 15 years)
- Death benefit: $250,000
- Loan taken: $50,000
- Loan interest rate: 5.0% annual, compounded annually (no payments made)
- Policy crediting/dividend: cash value grows at 3.0% annually (a conservative illustrative rate)
- Time horizon shown: 10 years
Key points to track each year: starting cash value, interest on loan, loan balance, credited growth to cash value, ending cash value available (cash value minus loan), and death benefit (original minus loan balance).
| Year | Starting Cash Value | Loan Balance Start | Loan Interest (5%) | Cash Value Growth (3%) | Ending Cash Value | Ending Loan Balance | Available Cash Value (EV) | Death Benefit (if loan unpaid) |
|---|---|---|---|---|---|---|---|---|
| 0 | $120,000 | $50,000 | $0 | $0 | $120,000 | $50,000 | $70,000 | $200,000 |
| 1 | $120,000 | $50,000 | $2,500 | $3,600 | $123,600 | $52,500 | $71,100 | $197,500 |
| 2 | $123,600 | $52,500 | $2,625 | $3,708 | $127,308 | $55,125 | $72,183 | $194,875 |
| 3 | $127,308 | $55,125 | $2,756 | $3,819 | $131,127 | $57,881 | $73,246 | $192,119 |
| 4 | $131,127 | $57,881 | $2,894 | $3,934 | $135,061 | $60,775 | $74,286 | $189,225 |
| 5 | $135,061 | $60,775 | $3,039 | $4,052 | $139,113 | $63,814 | $75,299 | $186,186 |
| 6 | $139,113 | $63,814 | $3,191 | $4,173 | $143,286 | $67,005 | $76,281 | $182,995 |
| 7 | $143,286 | $67,005 | $3,350 | $4,299 | $147,585 | $70,355 | $77,230 | $179,645 |
| 8 | $147,585 | $70,355 | $3,518 | $4,428 | $151,113 | $73,873 | $77,240 | $176,127 |
| 9 | $151,113 | $73,873 | $3,694 | $4,533 | $155,646 | $77,567 | $78,079 | $172,433 |
| 10 | $155,646 | $77,567 | $3,878 | $4,669 | $160,315 | $81,445 | $78,870 | $168,555 |
Notes on the example:
- Even though cash value grows at 3% and the loan interest is 5%, the loan balance grows faster than the credited cash value. That narrows the net cash value (“available cash value”) over time. In this example, available cash value increased slightly early on because the cash value base was large; however, if the loan were larger or the crediting rate lower, available cash value would shrink faster.
- The death benefit falls as the loan balance grows. After 10 years, the death benefit in this example is roughly $168,555 instead of the original $250,000 (a reduction of $81,445, which equals the loan balance).
- Because interest is compounding, unpaid loans can eventually exceed cash value if not managed, risking policy lapse.
If instead you make loan payments (e.g., interest-only or principal+interest), the loan balance grows slower and the danger of lapse declines. Many policyowners make interest-only payments to prevent compounding from eroding the policy.
Pros, cons, and key risks
Borrowing from a life insurance policy can be powerful — but it’s not free money. Below is a simple table that summarizes typical advantages and disadvantages to help you decide whether a policy loan might fit your needs.
| Pros | Cons / Risks |
|---|---|
| Fast access to funds — often same-day or within a few business days | Interest accrues; unpaid interest compounds and increases loan balance |
| No credit check or underwriting required (after the policy is in force) | Loan reduces death benefit if unpaid, potentially leaving heirs with less |
| Flexible repayment — you choose the schedule | Policy lapse risk if loan balance grows too large relative to cash value |
| Loans are generally tax-free while policy remains in force | If policy lapses or becomes a Modified Endowment Contract (MEC), loans can become taxable |
| Can be cheaper than high-interest consumer loans in some cases | Opportunity cost: tapping cash value reduces the policy’s compound growth potential |
Key risks to watch:
- Lapse risk: If the loan plus interest approaches the policy’s cash value, the insurer may lapse the policy if premiums aren’t paid. Lapse can create a taxable event and loss of insurance protection.
- Interest-rate mismatch: If the loan interest rate is higher than the policy’s crediting rate (common), your net position degrades over time unless you repay.
- Heirs’ outcome: A large unpaid loan will reduce the death benefit — sometimes significantly — diminishing the policy’s original purpose of providing financial protection to beneficiaries.
- MEC rules and tax traps: Certain policy designs and excessive borrowing or withdrawals can trigger Modified Endowment Contract rules or taxable distributions. Professional advice is wise for complex moves.
How to borrow from your life insurance: step-by-step
If you decide a policy loan might help, here are clear steps to take. This process is similar at most insurers, but specifics may differ.
- Check your policy type and cash value. Review your annual policy statement or call your insurer to confirm the available cash value and loan provisions. Some policies allow borrowing up to 90% of cash value; others limit loans to a lower percentage.
- Understand the loan rate and mechanics. Ask the carrier whether the loan rate is fixed or variable, how interest accrues (daily, monthly, annually), and whether margin adjustments or caps apply.
- Determine how much you really need to borrow. Borrow the minimum you need. Larger loans have greater long-term risk of lapse and erosion of the death benefit.
- Request the loan in writing or via the carrier’s portal. Many insurers permit online requests; others require a form. Specify whether you want a check, electronic transfer, or policy collateral assignment.
- Decide on a repayment plan. Even if the policy allows you to defer payments, plan a repayment schedule (interest-only monthly, or principal+interest) to avoid compounding.
- Monitor the policy regularly. Track cash value, loan balance, and insurer notices. Get an annual illustration showing projected values under different interest and payment scenarios.
- Consult professionals when necessary. If you plan a large loan, to use the funds for complex estate planning, or to change coverage, consult a financial planner or tax advisor to understand tax and estate implications.
Example of a simple repayment plan:
- Loan: $50,000 at 5% interest.
- Interest-only monthly payments: about $208/month (5% of $50,000 ÷ 12).
- If you pay interest only, the principal remains $50,000 but you avoid interest compounding.
- To fully amortize the loan over 10 years, monthly payments would be approximately $530/month (using a simple loan amortization formula).
Tax, estate, and planning considerations
Policy loans are attractive in part because of favorable tax treatment — but there are important caveats and planning considerations:
- Generally tax-free while policy is in force: Loans are not considered taxable income because you’re not receiving income; you’re receiving a loan. However, this protection holds only while the policy remains active and not a MEC.
- Policy lapse or surrender: If the policy lapses or is surrendered with an outstanding loan, the loan may be treated as a distribution. The taxable portion equals the amount by which the distribution exceeds your policy basis (total premiums paid). For example, if you paid $60,000 in premiums and surrender the policy with an outstanding $80,000 loan, you could face taxable income on the portion that exceeds your basis.
- Modified Endowment Contract (MEC): Certain large premium payments relative to death benefit can turn a policy into a MEC. MEC status changes tax rules for distributions and loans, often making them taxable and potentially subject to penalties if the insured is under 59½.
- Estate tax considerations: If the insured’s estate is the beneficiary or if no beneficiary is named, the policy proceeds may be included in the estate for estate-tax purposes. Outstanding loans reduce the net death benefit, which can alter estate planning strategies. In some cases, loans can be used strategically to reduce estate liquidity issues, but this should be coordinated with estate counsel.
- Impact on need for coverage: Borrowing can reduce the death benefit your beneficiaries receive. If the original purpose of the policy was to replace income or pay off a mortgage, ensure the remaining net benefit still meets those needs.
Tax examples (illustrative):
| Scenario | Policy Basis (premiums paid) | Outstanding Loan | Surrender Value | Taxable Income |
|---|---|---|---|---|
| Policy surrendered with loan | $60,000 | $50,000 | $70,000 | $10,000 (70k surrender – 60k basis) |
| Policy lapses with loan | $100,000 | $120,000 | $0 (policy lapsed) | $20,000 (loan amount exceeding basis taxed) |
| MEC with distribution | $200,000 | $150,000 | $250,000 | Tax treatment less favorable; distributions taxed LIFO plus possible 10% penalty if under 59½ |
Because tax and estate rules are complex and depend on your personal situation, involve your CPA and estate attorney if you’re planning large loans, policy exchanges, or surrenders.
Alternatives to policy loans and when to choose them
Borrowing from your life insurance is one route among many. Depending on your needs and the cost of capital, alternatives might be more appropriate:
- Home equity line of credit (HELOC): If you own a home with sufficient equity, a HELOC can offer larger loan amounts and potentially lower rates (e.g., prime-based variable rates starting around 6% historically), but it uses your home as collateral.
- Personal loan or bank loan: Unsecured personal loans are convenient but often have higher rates (7%–20% or more for lower credit scores).
- 401(k) loan or distribution: You can borrow from retirement plans, often at low rates, but distributions can cause taxes and penalties; loans must be repaid quickly if you change jobs.
- Cash surrender: Surrendering the policy gives you full cash surrender value, but you lose coverage and may trigger taxes and surrender charges.
- Partial surrender / withdrawal: Some universal life policies allow withdrawals up to the basis amount tax-free. Withdrawals reduce cash value and death benefit differently than loans.
How to choose:
- Compare effective after-tax cost. Policy loans may appear low-cost but can become expensive if interest exceeds crediting; other loans have explicit rates and different collateral.
- Consider liquidity and speed. Policy loans are fast and don’t require underwriting. HELOCs and bank loans may take longer.
- Consider what you’re willing to risk as collateral. Policy loans use policy cash value; HELOC uses your home; other loans may use assets or have no collateral but higher rates.
- Think about long-term goals. If the policy is a key element of your estate plan, borrowing could undermine those plans.
Frequently asked questions and quick answers
Below are common questions people ask about borrowing from life insurance, with concise answers.
- Q: Can I borrow from a term life insurance policy?
A: No. Standard term policies do not build cash value and therefore do not support loans. - Q: Do I have to make monthly loan payments?
A: No. Most insurers allow you to defer payments. But unpaid interest compounds and increases the loan balance and risk to the policy. - Q: Is the loan amount taxable?
A: Generally not while the policy remains in force. If the policy lapses or is surrendered with an outstanding loan, there can be taxable income to the extent distributions exceed your cost basis. - Q: Can I borrow the full cash value?
A: Usually not the full cash value. Insurers typically limit loans to a percentage of cash value to preserve policy solvency — often 90% or less depending on the contract and type. - Q: How quickly can I get a policy loan?
A: Fast — many insurers can issue funds within 24–72 hours after processing the request. Timing depends on the carrier and transfer method. - Q: What happens to my beneficiaries if I have an outstanding loan when I die?
A: The outstanding loan plus accrued interest is subtracted from the death benefit, reducing what beneficiaries receive. Beneficiaries can often choose to repay the loan to receive the full benefit, but the loan must be repaid with other estate funds.
Practical checklist before borrowing from a policy
Use this short checklist to avoid common mistakes:
- Confirm current cash value and allowable loan amount with your insurer.
- Get the loan terms in writing: interest rate, compounding frequency, and any fees.
- Model outcomes: ask the insurer for an updated in-force illustration showing projected cash values, loan balance, and death benefit under different scenarios (no payment, interest-only, full amortization).
- Decide on repayment strategy and set up automatic payments if practical.
- Discuss with your financial planner and tax advisor if loan amount exceeds $25,000 or affects estate planning.
- Keep documentation and monitor the policy annually.
Summary and final thoughts
Borrowing from life insurance is a unique financing tool: it offers quick access to money, flexible repayment, and generally favorable tax treatment while the policy remains in force. The trade-offs are interest costs, potential erosion of death benefits, and the risk of policy lapse if loans are unmanaged. Whole life, universal life, indexed universal life, and variable life policies typically allow loans; term policies do not.
If you plan to borrow, do the homework: check how much you can borrow, the exact loan rate and compounding method, and request updated illustrations showing long-term impacts. Consider alternatives like a HELOC or personal loan if the cost or risk of borrowing from the policy is too high. For larger or complex moves, consult a financial planner, tax professional, and estate attorney.
Used carefully, policy loans can be a helpful part of your financial toolbox. Used carelessly, they can reduce the protection you intended for your loved ones. Approach policy lending with clear numbers, a repayment plan, and professional guidance when needed.
Note: This article is for informational purposes and does not constitute tax, legal, or financial advice. Rules and rates vary by insurer and by jurisdiction; always consult qualified professionals before making large financial decisions.
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