Should You Borrow From Your Life Insurance Policy?
Traditional life insurance was intended to give death benefits to beneficiaries in the case of the insured's death. There are now, however, certain life insurance packages that include a savings or investing component.
Some insurance salespeople highlight the advantages of life insurance that includes financial components. Among these advantages is the ability to borrow money from the policy's cash value after you've paid premiums. Whole life insurance and universal life insurance are two forms of cash-value life insurance plans. Check to discover if your life insurance policy includes a lending clause.
It sounds fantastic to be able to use your policy to get an emergency loan. However, be aware of the benefits and drawbacks of policy loans to avoid jeopardizing your coverage and paid premiums.
Can You Borrow Money From Term Life Policies?
Most of the time, you can withdraw cash from your life insurance policy after it has accrued cash value. To establish the cash value of your policy, you must contact your financial counselor or insurance agent. Discuss the ramifications for your policy, as well as any tax implications.
Cheap life insurance products, such as term life insurance, do not accumulate cash value. As a result, you are not permitted to borrow money from them. Because it is solely a life insurance coverage, term life insurance is quite economical.
Term life insurance has no value other than the death benefit paid upon the insured's death. And only if the insured dies during the defined duration.
Should You Borrow From Your Policy?
Before proceeding with a policy loan, consult with your financial planner to understand the long-term and short-term implications and dangers. There are other hidden charges that you may be unaware of, so you must be certain that this is the best option for you.
Request that your agent or advisor perform an "in-force illustration," which will show you how borrowing money may affect your insurance. Consider the benefits and cons, as well as other options. Keep the following points in mind:
- Determine the impact of the loan and interest on your coverage. Ascertain that the death benefit part is not jeopardized.
- Determine whether you will be required to pay an "opportunity cost."
- Check that you can afford the loan interest and other expenses. Interest expenses may be compounded, which means you may be paying interest on interest.
- Consider your options if you are unable to repay the interest on your loan.
- Take a thorough look at the facts with your planner if you rely on the policy's profits to pay the loan interest. Borrowing from the cash value of the policy reduces the amount of acceptable collateral for the loan. It also cuts dividends and generates less money to pay interest. This can be costly, and it may even result in the cancellation of your policy.
How Borrowing From a Life Insurance Policy Works
One significant distinction between policy loans and ordinary loans is that you are not required to repay the loan to your insurance policy. When you borrow based on the cash value of your life insurance policy, you are borrowing money from the life insurance company.
A loan from your life insurance policy can come in handy when you need money for a large price, such as college tuition. It may provide advantages over credit card debt or bank personal loans. Because it uses the cash value of your policy as security, an insurance company loan is also more easier to obtain than a bank loan.
On the other hand, this solution is not without risk. If you do not repay the loan, the insurance company will deduct it from the cash value of your policy or from the death benefit when it is paid out.
One of the biggest issues with this is that if you do not repay the loan and do not pay the interest, the interest will compound and be added to your loan sum. This sum may eventually exceed the monetary value of the policy.
Do You Have to Pay Back the Loan?
Unlike bank loans or mortgages, borrowing from a permanent life insurance policy does not require repayment. However, if you borrow money based on your cash value, the amount borrowed may diminish the death benefit from the life insurance element of your policy.
If you do not repay the loan and the interest combined with the amount borrowed begins to exceed the cash value, your life insurance coverage may be jeopardized. This policy danger may come sooner than you expect.
Why Borrow From a Life Insurance Policy vs. the Bank?
Policy loans are not appropriate in all cases, but they do have some advantages over typical lender loans.
Some people get cash-value life insurance to accumulate assets. They can then borrow from their policy or use the investments as needed later in life. Others prefer to draw from their insurance rather than take out a bank loan.
In most circumstances, borrowing from your life insurance policy gives for greater repayment flexibility. Rather than making fixed-term monthly payments to a bank, you can pay back as little or as much as you wish at any moment.
This could be a suitable alternative if you can repay your loan in a reasonable amount of time and keep up with the interest payments. Your life insurance agent can assist you in developing a strategy.
An Example of Borrowing From a Life Insurance Policy
Jane has been contributing to her full life insurance policy since she was 22. She resolved to purchase herself the sailboat of her dreams when she reached 40. She didn't want to borrow money, so she decided to use some of her savings. She also intended to borrow the final $20,000 from the cash value of her life insurance policy.
When Jane contacted to obtain the loan and consult with her financial counselor, she discovered that she could borrow the funds without difficulty. However, she discovered that the amount might diminish the amount of her death benefit. This means that if she died, her family would only receive the death benefit less the amount of the loan she had not yet paid.
Jane's advisor also informed her that, even though she was not required to repay the loan, she could end up paying interest and compounded interest. Jane determined that the yacht loan wasn't the best use of her acquired cash value after they worked out the details.
Instead, Jane decided to use the proceeds from her life insurance policy to create her own company. She was certain that she could repay her debt in two years because she had done market research and had some demand for her services.
The Bottom Line
Borrowing from your life insurance policy may be problematic if you do it because you have fallen on hard times. The cash value of your life insurance policy is protected from creditors in several states. However, any loan made from your life insurance policy is deemed cash, and once it is in your bank account, it is no longer shielded from debt collectors.
Don't take out a loan unless you understand the big picture. The first crucial thing to understand is that it is not the same as withdrawing funds from your savings account. It's a complicated transaction, and you must ensure that you grasp every facet of it.