Policy Loans: A Borrowing Option

Policy Loans: A Borrowing Option

Taking a loan from a cash value life insurance policy can be a simple method for borrowing money quickly, without some of the qualification issues one may face with other types of loans. The earliest policy loan practices, for example, which were permitted back in the 19^th century, took the form of loans to pay policy premiums. Later on, cash loans were made available. Today, a policy loan provision is required for policies issued in any state in which the Uniform Standard Provisions Law is in effect for all but short-term policies. While policy loans may fulfill a short-term financial need, they can also affect your long-term goals. Knowing the details will help you make the best decision for your unique situation.

A Closer Look

Basically, a life insurance policy loan is not a loan at all, but rather an advance of some of the cash value to which the policyowner is entitled by contract. In general, a policyowner has no accumulated funds in his or her name, but policies do illustrate specific values, allowing the holders to appreciate the benefits. However, borrowing from the policy may permanently reduce future proceeds for the policyholder’s beneficiaries. Therefore, it is important to determine how a loan, and your repayment schedule, may affect your death benefits.

Like most loans, policy loans accrue interest. For tax purposes, interest on a policy loan is considered “personal,” and therefore, is not tax deductible. Interest is charged primarily because the policy premium is computed on the assumption that all funds not used for current costs will be invested by the insurance company at not less than a specified rate of interest. Unpaid interest will be added to, and become part of, the loan principal. In certain circumstances, the accumulation of unpaid interest may cause the amount of a loan to surpass the cash value of the policy. Understanding the implications this may have on your current financial situation, as well as the potential effect it may have on your beneficiaries, is essential.

One can never be sure when the need for immediate funds will arise. So, you should consider borrowing from your life insurance cash values only for worthwhile purposes and plan on promptly repaying borrowed money. In general, many who contemplate borrowing against life insurance policy cash values consider it a last resort. Be sure to consult with a qualified insurance professional to learn more about your policy and tax implications a loan may have in your particular circumstances.

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