Loan On Life Insurance Policy: What You Should Know

When I sit down with clients who are exploring their policy options, one of the most common questions I hear is whether they can take a loan on life insurance policy. The short answer is yes—but only with certain types of policies, and understanding how these loans actually work can make the difference between a smart financial move and a costly mistake.

For a complete overview, see learn more about the MPI strategy.

Let me walk you through everything you need to know about borrowing against your life insurance policy, including how these loans work, what types of policies allow them, and some strategic ways people use this feature that might surprise you.

What Types of Life Insurance Allow Policy Loans?

Not all life insurance policies are created equal when it comes to borrowing. Here’s the breakdown:

Policies that allow loans:

• Whole life insurance
• Universal life insurance
• Indexed universal life (IUL) insurance
• Variable universal life insurance

Policies that DON’T allow loans:

• Term life insurance (no cash value to borrow against)
• Group life insurance through employers

The key factor is cash value. You can only borrow against policies that build cash value over time. Term life insurance is pure protection—you pay premiums, you get coverage, but there’s no savings component to access.

How Do Policy Loans Actually Work?

This is where many people get confused, so let me use an analogy that makes it crystal clear.

Think of your cash value like a bucket of water. When you take a policy loan, you’re not actually taking water out of the bucket—you’re putting a lien against it. The insurance company gives you money and uses your cash value as collateral, but that full amount stays in your policy and continues earning whatever growth or interest it was earning before.

Here’s what happens step by step:

1. You apply for a loan from the insurance company (not a bank)
2. The company loans you money up to a certain percentage of your cash value (usually 90-95%)
3. Your cash value remains in the policy and continues growing
4. You pay interest on the loan (typically 4-6% annually)
5. You can repay on your schedule or let the loan stay outstanding

The Key Advantages of Policy Loans

No Credit Check Required

Since you’re borrowing against your own money, the insurance company doesn’t need to check your credit. Even if your credit score has taken a hit, you can still access your cash value.

Flexible Repayment

Unlike bank loans with fixed monthly payments, policy loans offer incredible flexibility. You can:

• Make regular payments
• Pay it off early with no prepayment penalty
• Make interest-only payments
• Skip payments entirely (though interest will compound)

No Tax Consequences (When Done Right)

Policy loans are generally not treated as taxable income, which makes them a powerful tool for accessing money without creating a tax bill. Compare that to withdrawing from a 401(k) or traditional IRA, where every dollar is taxed as ordinary income.

Potential Risks to Understand

I always believe in giving my clients the full picture, including the risks:

Interest Compounds

If you don’t make payments, the loan interest compounds. Over time, this can eat into your death benefit or even cause the policy to lapse if the total loan exceeds the cash value.

Reduced Death Benefit

Any outstanding loan balance reduces the death benefit paid to your beneficiaries. If you borrowed $50,000 and haven’t repaid it, your beneficiaries receive $50,000 less than the face value of the policy.

Policy Lapse Risk

If loan interest causes the total debt to exceed the policy’s value, the policy could lapse. This creates a taxable event—you’d owe taxes on any gains above what you paid in premiums.

Strategic Uses for Policy Loans

Over the years, I’ve seen clients use policy loans creatively and effectively:

Emergency Funding

Life throws curveballs. I’ve had clients use policy loans for medical emergencies, job loss, or unexpected home repairs. The money is available quickly, and there’s no lengthy approval process.

Investment Opportunities

Some clients borrow against their cash value to invest in real estate or business opportunities. The key is ensuring the return on investment exceeds the loan interest rate.

Supplemental Retirement Income

This is where things get interesting. Some people design their life insurance specifically as a retirement income vehicle. By borrowing against their cash value in retirement, they can access tax-advantaged income while keeping their principal intact and growing.

The MPI Strategy: Maximizing Policy Loan Benefits

Speaking of strategic policy design, I’ve been studying an approach called the MPI (Maximum Premium Indexing) strategy that takes policy loans to another level.

With a properly designed, max-funded indexed universal life policy using the MPI strategy, you can potentially:

• Build substantial cash value faster
• Use participating loans that allow your full cash value to keep earning index-linked growth
• Access retirement income at potentially higher distribution rates than traditional accounts

The participating loan feature is particularly interesting—when you borrow, your cash value doesn’t stop earning. If the index credits exceed the loan interest rate, you’re actually profiting on borrowed money.

Let me give you a real-world example of how this could work:

Your cash value earns 8% index-linked growth while you pay 4% loan interest. That 4% spread means you’re making money on money that isn’t even technically yours. It’s like borrowing from the bank at 4% and investing it at 8%—except it’s all happening within the same insurance contract with tax advantages.

Loan Terms and Mechanics

When you take a loan on life insurance policy, here are the typical terms:

Loan-to-Value Ratio: Most companies allow you to borrow 90-95% of your cash value Interest Rates: Currently around 4-6%, with maximum rates specified in your contract Repayment Terms: Completely flexible—you set the schedule Processing Time: Usually 5-10 business days once paperwork is complete

Tax Implications You Should Know

The tax treatment of policy loans is one of their biggest advantages, but there are some nuances:

While the policy is in force: Loans are generally not taxable income If the policy lapses: Any outstanding loan balance above your basis (premiums paid) becomes taxable Death benefit: Loan balances are deducted from the death benefit, but beneficiaries don’t pay taxes on the loan

This is why keeping the policy in force is crucial if you have outstanding loans.

Comparing Policy Loans to Other Options

Let’s be realistic about when policy loans make sense versus other borrowing options:

Policy loans might be better when:

• You need quick access without credit checks
• You want tax-advantaged borrowing
• You have poor credit
• You’re in retirement and want to avoid taxable distributions

Traditional loans might be better when:

• You can get a lower interest rate elsewhere
• You want to preserve your full death benefit
• You don’t have sufficient cash value built up yet

Making the Right Decision for Your Situation

The ability to take a loan on life insurance policy is a valuable feature, but it’s not right for everyone or every situation. The key is understanding how it fits into your overall financial strategy.

If you’re considering a policy primarily for the borrowing feature, make sure you’re looking at policies designed for cash value accumulation—like whole life or indexed universal life with maximum funding strategies.

If you already have a policy with cash value, consider whether borrowing against it makes more sense than other options given your current interest rates, tax situation, and repayment ability.

Questions to Ask Yourself

Before taking a policy loan, consider:

• What’s the loan interest rate versus other borrowing options?
• How will this affect my death benefit and beneficiaries?
• Do I have a realistic repayment plan?
• Are there tax implications I need to understand?
• Could this money work harder for me elsewhere?

The life insurance market offers incredible flexibility when you know how to use it strategically. Whether you’re looking at policy loans as an emergency backup, retirement income strategy, or wealth-building tool, the key is working with someone who understands how these features actually work in practice.

Need help evaluating your options? I work with multiple top-rated carriers and can help you understand exactly how policy loans would work with your specific situation. Contact me for a personalized consultation and let’s explore what makes sense for your financial goals.

Related Reading

• MPI Investment: What You Should Know
• LIRP Life Insurance: What You Should Know
• Benefits of IUL: What You Should Know
• Indexed Universal Life Insurance Pros and Cons