Cash Value and Policy Loans: Using Your Life Insurance During Lifetime
The main reason to buy life insurance is to protect your family with a death benefit. But permanent life insurance can do more by building cash value over time. You may be able to use this money later for income, especially during life’s unexpected moments.
Cash Value of Life Insurance
When you pay your premium, part of the money pays for the insurance. The rest goes into your policy’s cash value. Over time, the cash value can grow with credited interest. What’s better, the growth is tax-deferred.
Potential Tax-Free Income from Life Insurance via Policy Loan
If your policy has enough cash value, you may be able to borrow against it. Because loans are generally not considered income, the money you receive is typically income tax-free. However, a loan is not free money. It must be repaid, and interest will apply.
Financial Flexibility through Loans
A policy loan may provide flexibility when you need it most. Here are a few potential examples:
- Supplement retirement income.
Many people find it difficult to make their retirement savings last. Policy loans can potentially help supplement your income during retirement. - Cover a short-term need.
If you are between jobs or facing an unexpected expense, a policy loan may help fill the temporary gap. - Pay off higher-interest debt.
If you have high-interest debt, you may choose to borrow from your policy instead if the policy loan’s interest rate is lower. - Support your business.
Business owners may use policy loans to manage cash flow or take advantage of growth opportunities.
How Can You Access Cash Value?
Companies vary as to when cash value may be borrowed and how much is available to borrow. Your available loan amount will also vary based on how much cash value your policy has built.
Cash value does not grow overnight. It may take several years to build a meaningful amount. The more you fund your policy (within IRS limits), and the earlier you start, the sooner cash value may become sufficient for your needs.
You Can Do This
Start today.
Meet with a financial professional to see if permanent life insurance may fit your financial goals. If you already have a policy, review it to understand your current cash value and loan options.
Frequently Asked Questions
How much can I borrow?
You can usually borrow a percentage of your policy’s cash value. The exact amount depends on your policy and the insurance company.
Your financial professional can help you understand how much is available to you.
Are policy loans always income tax-free?
Policy loans are generally not considered income, so they are typically income tax-free.
However, your policy must follow IRS rules. If not, income taxes may apply. It’s important to have a financial professional help design your policy to meet your goals.
Is there interest on a policy loan?
Yes. Policy loans charge interest. If you do not pay the interest, it is added to your loan balance. The interest rate is set by the insurance company.
How is a policy loan repaid?
You can repay a loan at any time while you are living.
If the loan is not repaid and you pass away, the remaining loan balance (plus interest) will be taken from the death benefit. The rest of the death benefit will go to your beneficiary.
How does a loan affect my policy’s cash value?
When you take a loan, part of your cash value is used as collateral.
Depending on your policy, that collateral part of the cash value may continue to earn interest. In some cases, it may earn more than the loan interest charged. In other cases, it may earn less and be harmful to the policy. Therefore, loans should be managed carefully.
How does a loan affect my death benefit?
Any unpaid loan balance will reduce the death benefit paid to your beneficiary.
What happens if the loan grows too large?
If your loan plus interest becomes larger than your cash value, your policy could lapse.
If that happens, you may lose coverage and could owe taxes. That’s why it’s important to monitor and manage loans carefully.
How are policy withdrawals different from loans?
When you take a loan, you use the cash value as collateral in your policy. When you take a withdrawal, you are taking cash value from the policy.
Withdrawals may cause immediate taxes, depending on your situation. Loans are generally not taxable when taken, but they must be managed properly.
How do I get started?
Talk to a financial professional:
- If you already have a policy, review your cash value and loan options.
- If you do not have coverage, discuss how permanent life insurance can help protect your family, give you peace of mind, and potentially offer added benefits like cash value.
A conversation can help you understand your options and make an informed decision.
Yining Eads
Yining Eads is an attorney of National Life Group Advanced Sales Team. She received her J.D. degree and Tax LL.M. degree from the University of Washington School of Law. She is admitted to the State of Washington Bar Association, and she speaks both English and Mandarin Chinese. Before she joined National Life Group, she was in private practice with focuses on estate planning and tax dispute resolution practices. In her practice, Yining has helped high-net-worth individuals and families design sophisticated wealth passing plans. She is also an expert in cross-border planning and has assisted individuals and families that have ties with the United States to minimize U.S. gift and estate taxes.