Need Access to Funds? Consider a Life Insurance Loan

Considering a Loan Against the Cash Value of Your Life Insurance Policy? Here is What You Need to Know

When thinking about ways to access liquidity during financial emergencies or to fund significant life events, borrowing against the cash value of your life insurance policy is a strategy many high-net-worth individuals overlook. Life insurance can be more than just a vehicle to provide for your family after you are gone—it can also offer living benefits through policy loans.

However, it is crucial to understand how this process works, its potential advantages, and the rules that govern such loans. In this post, we will cover why you might consider borrowing against your policy’s cash value and some important limitations to keep in mind.

What Does It Mean to Borrow Against the Cash Value?

If you own a permanent life insurance policy, such as whole life or universal life, a portion of your premium payments goes toward building a cash value component within the policy. Over time, as the cash value grows, it becomes an asset you can borrow against. Unlike traditional loans, policy loans do not require an application process or credit check since you are essentially borrowing from yourself.

Key Benefits of Borrowing Against Life Insurance

  1. Tax-Free Access to Funds: One of the most attractive aspects of borrowing against a life insurance policy is that the loan proceeds are generally not considered taxable income. This means you can access cash without triggering a tax event, which can be particularly advantageous in certain financial planning scenarios.
  2. No Strict Repayment Terms: Unlike conventional loans, there is no fixed repayment schedule for a life insurance loan. You are free to repay the loan over time, or not at all. However, if you do not repay the loan, the balance (plus interest) will be deducted from the death benefit your beneficiaries receive.
  3. Lower Interest Rates: Life insurance loans often have lower interest rates compared to traditional loans or credit lines. Additionally, because the loan is secured by the cash value of the policy, there is less risk of default.
  4. Easy Access to Funds: Loans against life insurance can provide fast access to liquidity, which can be helpful during times when you need immediate cash—whether to cover emergency expenses, invest in a business opportunity, or fund a large purchase.

Potential Drawbacks to Consider

While borrowing against the cash value of your life insurance can be beneficial, there are some downsides you should be aware of:

  1. Impact on Death Benefit: If you do not repay the loan, the outstanding balance and any accrued interest will reduce the death benefit your beneficiaries receive. This could impact the financial legacy you intended to leave behind.
  2. Interest Accumulation: Although interest rates are generally lower, it is important to remember that interest does accumulate on the loan. Over time, this can significantly reduce the available cash value and the death benefit if the loan is left unpaid.
  3. Lapse Risk: If the loan balance plus interest exceeds the policy’s cash value, the policy could lapse, meaning you lose both the insurance coverage and the accumulated cash value.

When Should You Consider a Policy Loan?

Here are a few scenarios where borrowing against your life insurance policy could be an advantageous financial move:

  • Emergency Expenses: If you face an unexpected medical expense or financial crisis, borrowing against your policy’s cash value can provide quick access to funds without having to liquidate other investments or assets.
  • Business Opportunities: If you come across an investment or business opportunity that requires immediate capital, a policy loan can serve as a low-interest, easily accessible source of liquidity.
  • Supplementing Retirement Income: For those nearing or in retirement, taking out a policy loan can serve as an additional income stream without triggering taxable events, helping to supplement retirement savings.

You could also consider a loan against a policy currently held in a trust.  However, only the policy owner can access the cash value.  So if you have a policy in a trust, the trust can access that cash value but it can ONLY distribute it to the trust’s beneficiaries. 

Conclusion

Taking a loan against the cash value of your life insurance policy can be a valuable financial tool, offering flexibility and tax benefits while providing access to needed funds. However, it is essential to ensure that the policy is owned personally and not placed in a trust if you plan to utilize this option. 

At Lindberg & Ripple, we work closely with individuals to evaluate their financial goals and determine the best strategies for leveraging life insurance in their overall wealth management plan. If you are interested in learning more about how a policy loan might fit into your strategy, contact us today to schedule a consultation.

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For important information related to Lindberg & Ripple, refer to the Lindberg & Ripple Client Relationship Summary (Form CRS) found here.

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