Life insurance loans are powerful tools that most Americans have never heard of – but they should. This under-the-radar financing strategy has been used by the wealthy for generations to build businesses, invest in real estate, and create tax-free retirement income.
Think of a life insurance loan like having your own private bank. You can access capital whenever you need it, without credit checks or waiting for approval. Best of all? Your money keeps growing in your policy even while you’re using it elsewhere.
“But wait,” you might be thinking, “If I can borrow against my policy, doesn’t that reduce my interest and dividends?” Not exactly. That’s one of the many misconceptions about policy loans we’ll clear up in this guide.
We’ll show you exactly how life insurance loans work, when to use them (and when not to), and why they’re such a valuable part of a solid financial strategy. From basic concepts to advanced tax strategies, we’ve got you covered.
Table of Contents
- Life Insurance Loans Pros and Cons
- How do life insurance loans work?
- How Much of the Cash Value Can I Borrow Against?
- Do Life Insurance Loans Have to be Paid Back?
- How To Get A Life Insurance Loan
- What happens if I die with an outstanding policy loan?
- What Do I Use Loans from Life Insurance For?
- Are Life Insurance Loans Taxable?
- Can You Deduct Life Insurance Loan Interest?
- Conclusion
Life Insurance Loans Pros and Cons
We will address these pros and cons within the context of this article but for brevityโs sake, here are some pros and cons of life insurance policy loans within the context of a mutual life insurance company.
Pros
- Life insurance loans are tax free and your money continues to grow tax deferred in your policy based on cash value guarantees and potential dividends
- You can pay back your loan at any time (or never). You make the rules, although we do recommend you at least pay the interest.
- You set the repayment terms. You can pay annually, monthly, quarterly, or as mentioned above, never.
- With the best cash value companies you will pay a low interest rate on the policy loan in contrast to other types of loans, typically in line with how much your policy is earning in interest, making it a “wash” or “zero-interest net” loan.
- You can take a policy loan at any time, and for any reason, with no credit check or qualification necessary.
- The loan is private and does not show up on your credit report and does not effect your credit score.
- Unlike traditional retirement savings plans, such as 401k plan loans, there are no penalties associated with taking out a life insurance loan.
Cons
- Unpaid policy loans and accrued interest count against your total death benefit or surrender value at the time of claim or termination of the policy.
- Your policy could lapse if you are not diligent in monitoring it, which could lead to a taxable event.
Some Contextโฆ
Now, before we start singing the praises of why life insurance policy loans are so fantastic, we need to bring in some context. At I&E, we believe one of the best vehicles for wealth creation is whole life insurance.
And when we say “whole life insurance”, we are referring to the best whole life insurance that offers an annual dividend, from a mutual insurance company.
In addition, the policy would be structured properly to allow the owner the ability to use the policy for personal financing.
So how does one use a policy for personal financing?
You do this by implementing the strategies associated with the infinite banking conceptยฎ.
How do life insurance loans work?
When you take out a life insurance loan you are borrowing money from the insurance companyโs general account, using your cash value as collateral.
You see, you are not actually borrowing your own money, but the insurance companyโs money.
The cash value in your policy remains in your policy, continuing to grow via compound interest. And this right here is a huge benefit, because where else do you earn true compound interest, other than in a guaranteed account?
Now, the insurance company loans you money that was earmarked for policy owner loans, investing in bonds, investing in real estate, or investing in other investment grade securities.
So, even though you took out a loan against your life insurance cash value. the cash in your policy continues to grow via guaranteed interest and potential dividends, That means your cash value is continuing to grow via compound interest, even though you are using it as collateral to purchase other income producing assets!
How Much of the Cash Value Can I Borrow Against?
The great thing about the best whole life insurance companies for building wealth is that they allow you to use the policy’s cash value as collateral and borrow up to 90% of the cash via policy loans, for whatever reason you need it for, anytime you want.
Loan interest begins to accrue as soon as the loan is effective.
The players in life insurance consist of the company, the owner, the insured and the beneficiary.
Sometimes the owner and insured are different, but often they are the same person.
You can think of your life insurance policy as a home that you either own or rent.
Similar to term life vs whole life insurance, where you own your policy (whole) or you are renting your policy (term).
Renting vs Owning
Cash value life insurance is more akin to home ownership. You own the policy and the equity in the policy, which is similar to owning the home and the equity in the home. You are the owner and as such, you may borrow against the policy at any time while the insured is living.
Term life insurance is more akin to renting a home, since you do not own the equity in the home. There is no cash value with term life, so you cannot borrow against it. And chances are that when you most need the home equity (i.e. when you die) you are going to be kicked out (your term policy expires) before you can cash in.
The analogy only goes so far because one distinct advantage with permanent life insurance you can take out a policy loan whenever you choose, no questions asked. But with home ownership, if you want to tap into the equity you have to qualify. And a bank is going to ask a lot of questions, which often makes it difficult to access your home equity when you need it most.
Do Life Insurance Loans Have to be Paid Back?
No, life insurance loans do not have to be paid back. If you donโt pay back your loan interest the carrier will simply add the interest to your outstanding loan balance.
And interest on a life insurance loan is not due right away. Rather, interest is due on each policy anniversary date.
If interest is not paid when due, it will be added to the loan, provided it does not exceed the maximum loan available, and will bear interest at the rate payable on the loan.
And as you pay back your loan with interest, the money goes into the companyโs general account, and not into your policyโs cash account.
The Self Banking Blueprint
A Modern Approach To The Infinite Banking Concept
Fixed vs Variable Loans
The type of interest rate on any policy loan will vary on the carrier you choose and the options available with that particular carrier.
Some companies offer a fixed loan rate, but it is going to be higher than a variable loan rate. The variable loan rate is set by the insurance company. The rate changes from year to year, and from company to company. For example, some of the top mutual insurance companies currently offer variable loan rates ranging from 5.5-8.5%. For infinite banking whole life policies, we prefer companies that offer lower borrowing rates for policyholders.
How To Get A Life Insurance Loan
The steps to get a life insurance loan are as follows:
- See if your life insurance company offers an online loan request form. Many companies allow you to request a loan by logging into your account and filling out the online form.
- Alternatively, calling the life insurance company and requesting a loan is also a viable option.
- If the requested loan balance exceeds a certain maximum online allowable loan amount, you will need to fill out a form requesting a higher amount. The form is usually available online and can be faxed or emailed to the company.
- Once your life insurance loan amount is approved, the company will either mail a check that you can deposit or it will make a deposit into your bank account on file.
- The typical timeline to receive your funds is about 5-7 business days.
What happens if I die with an outstanding policy loan?
Now if you die with an outstanding life insurance loan, your loan and any interest due will be taken out of your death benefit.
For example, if you owe $100,000 and your death benefit is $500,000, your life insurance beneficiary will receive $400,000.
This is the main reason why mutual companies are so ready to loan to policyholders—the money is secured by your death benefit. There is no risk to the carrier.
In contrast, banks are much more cautious because the collateral a bank receives may not be as valuable.
So for another example, suppose you take out a real estate loan from a bank on a fixer-upper. The bank is using the property as collateral. But what if you allow the property to devalue? The bankโs collateral has gone down in value. And what if you default? The bank gets a dilapidated piece of real estate worth less than when the loan was given.
What Do I Use Loans from Life Insurance For?
Loans from life insurance can be used for anything. Here are just a few of the things you can use your loan for.
- Retirement Income. Supplement your retirement income with tax free policy loans as part of a solid life insurance retirement plan LIRP.
- Buy vehicles. Pay yourself back at the going interest rate and be your own finance company. (Nowadays, car loans are practically free money at 0-1%, so it makes sense to simply borrow money for a car if you qualify.)
- Pay debts. Use your loans to pay down debt and pay your loan back with interest to supercharge your policyโs cash value (and get out of debt).
- Buy assets, such as cash flow real estate. Consider using the cash flow to repay your policy loan. Once your loan is paid back, buy another property and use the cash flow to buy more cash value life insurance. Wash, rinse, repeat!
- Pay for college; yours or your kids. Consider life insurance for children as a great way to teach your kids about money and save for college and a future home.
- Invest in Business. Borrow money from your policy and loan it to your business. Have your business write off the interest and pay yourself back from your business.
- Pay for your daughterโs wedding. Recoup the cost of the wedding by charging yourself principle and interest on the borrowed money.
Are Life Insurance Loans Taxable?
As a general rule, life insurance loans are NOT taxable. Cash value life insurance obtains a favorable tax status under IRC 7702.
However, be aware that there is a potential taxable gain if your policy lapses or is surrendered while an outstanding loan exists. Any increase to your policy above your basis (i.e. what you paid into it) will be taxed as ordinary income.
MEC
An exception is if your policy is considered a Modified Endowment Contract (MEC). In that case, any loan you take will be taxable as ordinary income to the extent of the gain in the policy. Further, under MEC rules, if you are under age 59ยฝ, similar to a 401k plan, any taxable gain will incur a 10% penalty on top of any income tax owed.
Finally, for MECs, if you have loan interest due and you donโt pay it, the loan interest will be added to your principal balance and will be subject to income tax under the same rules.
Can You Deduct Life Insurance Loan Interest?
The interest that accrues from interest on a life insurance loan is not tax deductible. There may be an opportunity to loan your business money and have the business write off the interest on the loan but that is a question for a tax attorney and beyond the scope of this article.
Conclusion
The option to take out life insurance loans is one of the primary benefits of cash value life insurance. As you policy grows in value over the years, this benefit also increases in value, providing you with a secure financial foundation throughout your life. Plus, the death benefit provides for your loved ones upon your death.
For more on how you can benefit from this fantastic cash value life insurance feature, please give us a call today for a complimentary strategy session.
The Self Banking Blueprint
A Modern Approach To The Infinite Banking Concept
19 comments
Brian C
So it seems that this type of policy would not have much use until it has acrued a decent cash value. It would appear you can not start a 1m policy and 6 months in borrow 100k. Unless you prepaid up to over 100k. Unless I’m missing something.
Insurance&Estates
Hello Brian, you’re correct, and yet your approach may be missing something. “Not much use” could detract from the fact that if you add lump sums as part of a coordinated plan, you can have readily accessible cash that is also funding guaranteed growth, dividends, with tax benefits and a death benefit. We have many clients who opt for lump sums to expeditate available cash value growth.
Best, Steve Gibbs for I&E
John Starkel
In the article above one of ways to use a policy loan is to pay-off debt. When paying debt with interest can you please further explain how this โsupercharges your policy cash valueโ? Thanks in advance!!! John.
Insurance&Estates
Hi John, thanks for commenting. The idea behind policy loans with IBC is really about using the funds to purchase something that you would’ve purchased anyway, whether with cash or a conventional bank loan of some kind. The difference with cash and conventional loans is there is no momentum of having your cash working for you at the same time – you could call this opportunity cost of lost capital in the case of cash and with the conventional loan it is all downside. With a policy loan, you’re paying interest to use the cash; however, your cash value keeps working, with continuous compounding, dividends, etc., thereby keeping your money productive and moving (velocity). Then when you pay back the loan, you are recapturing those funds and potentially adding to them, something that is simply not available with the alternatives mentioned. The idea of supercharging is based upon this premise of paying your policy value back, this is somewhat intangible but can give your cash value and death benefit a boost. Depending upon the design of your policy, another way to potentially supercharge your cash value is to put back more cash than you took out by perhaps paying back what you’d pay with a conventional loan – say 8-10% for a hard money loan. Whether you can do this with your policy would depend on MEC rules and whether there is room for additional cash – the logic here would be to pay back your bank as you would a traditional bank or 3rd party lender. All of the above is case by case and would be discussed independently with your advisor.
Best, Steve Gibbs, for I&E
Daniel Ramirez
Great Article and explanation!
I do have the following question: Can you please explain how interest payed on a whole life loan finds its way back to the policy holder if at all? For example if I borrow 25k for the purchase of a car at an interest rate of 5% for a 5 year term. Interest for 25k loan for 5 years would be $6,250 bring the total of the the loan repayment to $31,250.00 I’m unclear as to how much of the $6,250.00 paid in interest would be credited or paid back to my account?
I understand that the insurance company will pay dividends on the cash value in the policy yearly but is this where capturing interest of whole life loans comes in? Hope this makes sense, thank you in advanced!
Insurance&Estates
Hi Daniel, thanks for your question. Because the cash was not removed from the policy’s cash value, the insurance company will both interest (guaranteed return) and dividends on the cash value in the policy. This is where the recapture of the interest paid on the policy loan is realized. In other words, your full cash value is working with true compounding growth regardless of your outstanding loan.
Best, Steve Gibbs for I&E
Nicole
What you fail to tell people in this article is that the interest earned is much much less than a 401k plan, and the interest on the loan is much much higher than the interest earned. For a loan, you have to pay back interest of 6-8%. Oh… And get this, you get either the cash value or the death benefit. Not both. So if you have a life policy at 100k, with a cash value of 80k (that you paid into it), you only get a death benefit of 20k from the insurance company (asked several companies about this, ask yours). So nah, think I’ll put together term and an investment account before touching a whole life policy ever.
Insurance&Estates
Hello Nicole, thanks for commenting.
I’d be remiss if I didn’t point out for you (and the benefit of our readers) that you’re missing a lot in your commentary of how whole life insurance works due to a few hugely incorrect assumptions.
I’m telling you this not only as an estate planner and advocate of life insurance but as someone who personally loves his whole life policy, soon to add another.
It’s clear that you’ve never considered a few key items such as: 1) how taxation and fees impact the performance of your 401(k) OR 2) what happens when you need life insurance, you’re 60 years old and your term expires…3) how to you address long term medical care and retirement when your 401(k) doesn’t perform as you’d hoped due to inevitable business cycles. These realities are HUGE when it comes to understanding the value of a properly structured whole life strategy as part of your plan.
Think if you could purchase a piece of real estate that offers a guaranteed return every year, and as it grows, it offers you access to a totally liquid tax deferred account that builds in a true compounding environment. Using real property as an analogy to a whole life policy (the latter of which is actually a superior asset) equity in the real property is like the cash value in the policy AND the house is the death benefit.
So in a whole life policy, the cash value account in a sense funds the death benefit….it isn’t forfeited. If you pass away with a piece of real estate in debt, the loan needs to be paid and the same goes for your policy. Its just that the policy is arguably a superior investment because the guaranteed tax deferred growth.
The other thing you may need to consider is the amount of time it will take to make up the loss if your 401k tanks as they did for many in 2007-2008. The effect of that lost principal takes longer to regain due to some simple math principles. You can run a calculator to compare whole life returns against more “traditional” investments and I know from experience that it would probably shock you. Simple math and deciding not to roll the dice with your future are important factors.
Also, your summary of interest rates and returns are exaggerated and misleading, both in terms of your rates mentioned and also because you’re failing to account for the impact of dividend rates which tend to rise in a higher interest rate environment.
As a sidenote, on the non-guaranteed side, mutual whole life dividends are generally backed by 100+ years of dividend paying history. There are also companies that offer a “margin lock” so that rates keep pace with returns.
When you run comparisons to dig deeper, understand that most “financial promoters” are touting the market’s best day using large moving averages against whole life returns that, by law, are only allowed to focus the guaranteed side on the interest, which is essentially whole life on its worst day.
Hope this is useful.
Best,
Steve Gibbs for I&E
Charisse Francis
This was very easy to understand, thank you so much for breaking it down the way you did!
Insurance&Estates
Charisse, thanks for commenting. It’s nice to hear your enthusiasm.
Best,
Steve Gibbs for I&E
Clementine
Which companies allows life insurance loans because I have one with sanlam and I need cash loan to pay all my debts
Fezeka
I need a life insurance loan plz i have 1 at 1life
Insurance&Estates
Fezeka, you should double check and makes sure you’re contacting your life insurance company. Sometimes folks get us confused because we write about various companies.
Best of luck to you.
Steve Gibbs, for I&E
Insurance&Estates
Hello and thanks for you comment. It is unclear from your comment what exactly your situation is so you’re welcome to connect with our Product Specialist, Jason Herring, at jason@insuranceandestates.com for more information.
Best, I&E
Loan Blog
A personal loan protection insurance helps you cover the inability to repay the loan due to unfortunate circumstances such as death, unemployment, or due to medical conditions.. This is the blog i have find.. Really very Helpful.. Thanks
James
Great article with helpful information.
Are you aware of any Life Insurance Carriers that offer policies with a fixed loan interest rate? Given the low interest rate environment, it would be great to lock in a low rate for life.
Thanks!
Insurance&Estates
Hi James,
Thanks for stopping by and we are glad you enjoyed the article.
To answer your question, yes, there are carriers that allow you to lock into a fixed loan interest rate. And we agree, it may be a good strategy to implement in this historically low interest rate environment we are in.
Please let us know if you have any more questions.
Sincerely,
I&E
daniel n ayertey
l need a life insurance loan
Insurance&Estates
Hi Daniel,
To get a life insurance loan you will need to have an existing cash value life insurance policy that has available cash value that you can use as collateral, allowing you to take out a loan from the life insurance carrier.
Sincerely,
I&E