Whole life insurance is a great method for creating a nest egg or cash value-building policy and it offers you a place to get cash if needed. How to borrow against a whole life insurance policy is a rather simple straightforward process however if you use it in a consumer method just to pay expenses you could be creating just as many problems long-term or more as you solve short-term. In addition, you will be ruining a very good asset that could serve you for your entire life.
To borrow against your whole life insurance policy is really just as easy as following the insurance company’s policy of requesting the funds and then waiting a couple of days to as long as a week(usually a week for brand new policies) to have the money deposited into your bank account.
Policy loan considerations
There is a minimum value needed to maintain a whole life insurance policy otherwise you run the risk of causing it to terminate. When you are considering taking a loan, ensure that you keep a good cushion of cash value left in the policy and repay the loans at least monthly so as to rebuild access to the full cash value and avoid problems from occurring.
How life insurance cash value works
When you pay premiums to whole life or other permanent life insurance policy that has a cash value component it grows on a regular basis. It is YOUR money, you own it. While the insurance company will charge interest on loans, there is no requirement for you to pay back your own money.
The cash value that accumulates is used as collateral for the policy loan that is made. This means that your money will stay in your account, the insurance company sends you their money, and if the loan is not repaid then the loan amount is taken from the cash value at the death of the insured.
So your beneficiary will likely get the cash value in the policy eventually, but with the option of taking loans, the owner of the policy can get access to that money while the policy is still in force to do with as they see fit.
What happens when you take a loan
If you are doing things on your own and not speaking with an agent then it is wise to speak with the insurance company and request an illustration that takes into account the policy loan. If you haven’t done so already find out what amount the cash value needs to be at in order to even take a policy loan.
Initiating a policy loan is usually as simple as calling the insurance company and requesting it, or printing out a form, filling it out, and then faxing or mailing it to them. Each company has a slightly different process so find out from your company directly what exact steps they specifically require.
With regards to asking the company what your policy looks like, ask for an in-force illustration that takes into account what the policy will look like after the loan has been made. Illustrations can be run with repayment in mind and without as well. Remember that loans charge interest from the insurance company so ask if you are going to be borrowing that interest in the illustration or make sure to include an interest rate with your repayment to cover it.
Understand all the loan terms
Is your loan going to have fixed interest rates, or variables? Are you taking the loan out early in the year, middle, or end of the year? These are just a few things you may ask about how it will affect the policy when calling.
Fixed interest rates are at a guaranteed rate so you’ll know how much will need to be paid each year, while variable rates change each year. Variable rates will be listed on your annual statement if you forget to ask the company.
Also to consider is if the interest is charged in advance or in arrears. If it’s in advance then at the time of policy loan interest will be charged for the remainder of the year and continues for each year the loan is being repaid. A payment made during the loan period will help reduce the amount owed through no credit or refund usually occurring.
Interest in arrears simply means the insurance company charges interest at the end of the policy year. When you take a loan out interest begins to accrue that day and any payments made in the middle of the year will reduce the interest owed at the end of the year.
What happens to your cash value after a loan
The great thing about a whole life insurance policy is that your cash value account is not reduced with policy loans. So what this means is that even with loans, your cash value still earns guaranteed interest every year and has the potential to earn dividends as well (for participating policies).
If something happens to you or your ability to pay your premiums the cash value can be used directly to pay that month’s premiums. This is not something you should rely on, however. Instead, I recommend contacting the insurance company if your ability to pay premiums has been affected and see what the minimum required is needed to keep the policy in force while you figure out your income status.
When taking a policy loan the insurance company does not send you a monthly statement for repayment. This is not that sort of loan as the money is yours and can be used as you want. If you decide to repay yourself then you need to create your own repayment schedule and stick to it.
Your insurance policy usually(I say usually because companies make changes and its possible one of them somewhere will start offering a way to track it but at the time of writing none I know of doing) will not send you a monthly illustration showing the loan and changes to the cash value based on repayment. Though like stated above you can ask for a policy illustration to see what will happen with various loan and repayment strategies.
Check this article out to see if you are actually getting the most of your money
Tax implications
First of all, I recommend having a tax advisor if you are making regular or perhaps a sizeable policy loan from a whole life policy. That being said, a simple rule of thumb is that no tax needs to be paid on loans that are from premiums paid, usually only on any excess earnings you have gained. Increasing your cash value through policy loans, paid-up additions, and loan repayments grows that total cash value amount. In addition, it helps increase the overall death benefit making the policy even more valuable later in life to your beneficiaries.
If you have questions regarding any tax questions related to your policy then you can also request from the insurance company what the cost basis is on the loan you took and see if there is any 1099 income tax that will be required to report.
For more information on how to use a policy in your finances feel free to reach out, I love making illustrations and going over different possible options to speed up getting out of debt or even better increasing income through utilizing a policy.