Taking out a loan against your life insurance policy can be a powerful financial tool when used correctly. I’ve helped many families understand how this feature works and when it makes sense to use it. Let me walk you through everything you need to know about life insurance loans.
For a complete overview, see our complete guide to MPI.
What Is a Life Insurance Loan?
A life insurance loan allows you to borrow money from your insurance company using your policy’s cash value as collateral. This isn’t the same as borrowing from a bank—you’re essentially borrowing your own money that has accumulated in your policy over time.
Here’s the key thing to understand: when you take a policy loan, you’re not actually withdrawing cash from your policy. Think of your cash value like a bucket of water. When you take a loan, you’re not taking water out of the bucket—you’re just putting a lien against it. The bucket stays full, and that full amount continues earning interest or credits, depending on your policy type.
How Life Insurance Loans Work
The mechanics are straightforward but important to understand:
Your Cash Value Stays Put When you borrow against your policy, your full cash value remains in the insurance company’s hands, continuing to grow according to your policy’s terms. You receive loan proceeds from the insurer’s general fund.
Interest on the Loan You’ll pay interest on the borrowed amount, typically ranging from 4% to 8%, depending on your policy and current rates. This rate is usually specified in your contract with a maximum cap.
No Credit Checks or Applications Since you’re borrowing against your own money, there’s no credit application process. The insurance company already has the collateral they need.
Flexible Repayment You can repay the loan on your own schedule—or not at all. If you don’t repay, the loan balance (plus interest) will be deducted from your death benefit when you pass away.
Types of Policies That Offer Loans
Not all life insurance policies have a loan feature. Here’s what does and doesn’t qualify:
Policies WITH Cash Value (Loan-Eligible)
- Whole Life Insurance: Generally offers loans after the first or second year
- Universal Life Insurance: Loan availability depends on cash value accumulation
- Indexed Universal Life (IUL): Often features participating loan options
- Variable Life Insurance: Allows loans against cash value
Policies WITHOUT Cash Value (No Loans)
- Term Life Insurance: Pure protection with no cash value component
- Group Life Insurance: Typically term coverage through employers
In my experience, whole life and properly designed IUL policies tend to offer the most favorable loan features for long-term financial strategies.
When Life Insurance Loans Make Sense
I’ve seen clients use policy loans effectively in several situations:
Emergency Funding
When unexpected expenses arise—medical bills, home repairs, or income interruption—your policy loan can provide quick access to funds without the hassle of bank applications.
Investment Opportunities
Some clients use policy loans to take advantage of time-sensitive investment opportunities, especially when the potential return exceeds the loan interest rate.
Retirement Income Strategy
This is where policy loans can really shine. With proper planning, policy loans can provide tax-advantaged retirement income. Since loans generally aren’t treated as taxable income, this can be more efficient than withdrawing from traditional retirement accounts.
Large Purchases
Rather than depleting savings or taking on high-interest debt, policy loans can fund major purchases like vehicles, home improvements, or education expenses.
The Participating Loan Advantage
Many modern IUL policies offer what’s called a “participating loan” feature, which I find particularly interesting. With participating loans, your full cash value continues earning index credits even while you have an outstanding loan balance.
Here’s why this matters: Let’s say you have $100,000 in cash value and take a $50,000 loan. With a participating loan, your full $100,000 continues earning index credits. If your policy credits 8% that year and you’re paying 4% loan interest, you’re earning a positive spread on the borrowed funds.
This feature can create some compelling opportunities for building wealth over time, especially when used strategically as part of a long-term financial plan.
Potential Risks and Considerations
Like any financial tool, policy loans come with considerations:
Outstanding Loan Impact on Death Benefit
Any unpaid loan balance reduces the death benefit paid to your beneficiaries. If you borrowed $50,000 and never repaid it, your beneficiaries would receive $50,000 less than the face amount.
Policy Lapse Risk
If loan interest compounds and the total loan balance approaches your cash value, your policy could lapse. This creates a taxable event if you have gains in the policy. Regular monitoring prevents this issue.
Opportunity Cost
Money you borrow isn’t available for other opportunities. While your cash value might continue growing, you’re still paying loan interest, which affects your overall return.
Tax Implications in Certain Scenarios
While policy loans are generally not taxable, if your policy lapses or is surrendered with an outstanding loan, you could face unexpected tax consequences.
Loan Repayment Strategies
You have several options for handling loan repayment:
Full Repayment
Pay back both principal and interest to restore your policy to its original state.
Interest-Only Payments
Pay just the interest to prevent the loan balance from growing while maintaining maximum flexibility.
Partial Repayment
Pay down some of the loan balance to reduce interest costs while keeping access to funds.
Let It Ride
Make no payments and let the loan balance be settled from the death benefit. This works well when the death benefit isn’t needed for beneficiaries.
Comparing Policy Loans to Other Borrowing Options
When clients ask about policy loans versus other options, here’s how they typically compare:
Policy Loans vs. Bank Loans Policy loans offer faster access, no credit requirements, and flexible repayment. Bank loans might offer lower rates but come with qualification requirements and structured payments.
Policy Loans vs. Home Equity Lines Home equity lines might offer tax-deductible interest and competitive rates, but they put your home at risk and require qualification. Policy loans don’t risk your primary residence.
Policy Loans vs. 401(k) Loans Both offer access to your own money, but 401(k) loans have strict repayment requirements and penalties if you change jobs. Policy loans offer much more flexibility.
Maximizing Your Policy Loan Strategy
If you’re considering using policy loans as part of your financial strategy, here are some principles I share with clients:
Understand Your Policy’s Loan Provisions
Different policies have different loan rates, crediting methods, and features. Read your contract or have someone explain the specific terms.
Monitor Your Policy Performance
Keep track of your cash value growth, loan balance, and overall policy performance. Most insurers provide annual statements that make this easy.
Consider the Big Picture
Policy loans work best as part of a comprehensive financial strategy, not as isolated transactions. Think about how they fit with your other financial goals.
Work with a Professional
The nuances of policy loans—especially with newer features like participating loans—benefit from professional guidance. Make sure you understand exactly how your policy works.
- Borrow against your cash value without credit checks or strict repayment schedules, accessing funds quickly while your money continues to grow in the policy.
- Understand that policy loans don’t withdraw cash from your account—your full cash value stays invested and earning while you pay interest on borrowed funds from the insurer’s general fund.
- Expect loan interest rates typically between 4-8% with flexible repayment options, including the choice to let unpaid balances reduce your death benefit instead of making payments.
- Check if your policy type qualifies for loans—whole life, universal life, and indexed universal life policies offer this feature, while term life insurance does not.
- Consider policy loans for emergencies, investment opportunities, or retirement income strategies when the benefits outweigh the interest costs and impact on your coverage.
The Bottom Line on Life Insurance Loans
A life insurance loan can be a valuable financial tool when you understand how it works and use it appropriately. The ability to access your cash value without taxes or credit applications provides flexibility that’s hard to find elsewhere.
The key is making sure you have the right type of policy and understand the specific features and costs involved. Not all policies are created equal, and the loan provisions can vary significantly between carriers and product types.
If you’re interested in exploring how a policy loan feature might fit into your financial strategy, I’d recommend talking with someone who can show you different options and help you understand the specific features available. Every situation is unique, and what works for one family might not be the best approach for another.
Related Reading
- Policy Loan Life Insurance: What You Should Know
- Retirement Income Solutions: What You Should Know
- Indexed Universal Life Insurance Pros and Cons
- MPI Investment: What You Should Know
Ready to explore your options? I help families compare life insurance policies from multiple top-rated carriers to find coverage that fits their needs and goals. Reach out for a free consultation and let’s discuss how the right policy design could benefit your family’s financial future.
