Q: What is a policy loan?
A: A policy loan is a loan from the insurance company. The policyowner’s cash value serves as collateral for the loan. Taking out a policy loan is not the same as withdrawing money from the account.
Q: Who can take out a policy loan?
A: The policyowner of a cash value life insurance policy can take out a policy loan up to the amount of cash value that has built up in the policy. Some insurance companies may cap the amount of a policy loan at a certain % of the cash value in order to protect against policy lapses.
Q: Can I take out a loan against a term insurance policy?
A: No. The cash value in your policy serves as collateral against a policy loan. Since term life insurance does not build cash value, the insurance company will not give you a loan against it.
Q: Will I be charged interest if I take out a policy loan?
A: Yes. The insurance company charges interest on policy loans. The interest, if not paid, will accrue and be added to the total loan balance.
Q: Why am I charged interest for a policy loan?
A: When the insurance company loans money to a policyowner, it is giving up the ability to earn interest on that money in other investments. In order to compensate for this opportunity cost, interest is charged on the policy loan. Not charging interest on policy loans would disproportionately harm those policyowners with no loans outstanding since they are not actively using the cash.
Q: Does my cash value continue to grow while I have a policy loan out?
A: Yes. Your cash value is still growing at a guaranteed rate and is eligible to earn dividends even while you have a policy loan outstanding–true uninterrupted compound growth. This is great because you are effectively using your same dollars for multiple purposes. With non-direct recognition insurance companies, your cash value earns the same dividend rate even if you have a policy loan outstanding. With direct recognition insurance companies, the amount of cash value serving as collateral for your policy loan will earn a dividend crediting rate that could be higher or lower than the unloaned portion depending on the loan interest rate.
Q: When do I have to pay back the loan?
A: You decide! One of the benefits of taking a policy loan is that the policyowner decides how and when to pay back the loan. There is no penalty for missing a payment. And, since your cash value serves as the collateral for the loan, there is no lien placed on your other assets. Work with your advisor to structure the payback schedule that works best for your situation and to make sure that the policy loan fits with your overall wealth building strategy.
Q: How is it possible that I am not penalized if I don’t repay my loan on time?
A: The insurance company is using the policyowner’s cash value as collateral for the loan. When the insured passes away, the unpaid loan balance and accrued interest will be taken from the death benefit to repay the loan. If the insured lives, but the unpaid loan balance plus accrued interest exceeds the policy cash value, the policy will lapse and the insurance company will take the cash value in order to pay off the loan. Finally, if the policy lapses due to a failure to pay the required premium, the insurance company will take whatever cash value is required to repay the loan and then return any remaining cash value to the policyowner. In this last instance, the policy is no longer in force and there could be tax consequences to the policyowner.
Q: How do I take out a policy loan?
A: The policyowner contacts the insurance company and requests a policy loan. The representative will then guide the policyowner through the process which is typically just filling out a request form, signing it, and returning it to the company. In some cases, the request can be made on the phone with no forms required. The money is then either deposited into the policyowner’s bank account or a check is mailed.
Always talk to your advisor when deciding whether or not to take a policy loan in order to determine how it will affect your long-term wealth strategy. While policy loans are an incredibly flexible and beneficial aspect of your life insurance policy, there are certain risks associated with them that could negatively impact your policy and overall financial picture. If you have further questions, please feel free to contact us at: firstname.lastname@example.org.