7 Things to Know about Life Insurance Loans

As you probably know, you can borrow against your whole life insurance policy. Some people do, and some people don’t. Sometimes, people borrow too much, too soon, and too often. Meanwhile, others miss out on opportunities because it doesn’t occur to them to use their policy.

If you have a whole life insurance policy (or are considering one), you should know the pros and cons of borrowing against your policy. Below you’ll find 7 things you should understand that will help you make good decisions and get the most out of your policy.

1.  No qualification needed.

You might think, “Of course I don’t have to qualify, it’s ‘my’ money,” but that’s not exactly true. A policy owner borrows against the policy, not from the policy. When you take a policy loan, you borrow from the insurance company (it’s their money, not yours) using your policy’s cash value as collateral. The quality of the collateral makes it easy to borrow against your policy—generally up to 90 or 95 percent of cash value.

This is important because many assets are not so easy to borrow against! Have home equity? Great! You’ll need to apply for a HELOC (home equity line of credit) or second mortgage. If you have a sudden interruption or decrease in income (a common reason you might want to tap your equity), you might not qualify. Already have a HELOC? If the real estate market has a downturn, your limit could be reduced or the line of credit could be halted altogether.

Other assets such as gold, collectibles, and mutual funds are also problematic to borrow against. (Read more in “The Leverage Test: Borrowing Against Assets.”)

2.  You can borrow against your policy for any reason.

You can use a policy loan for an emergency, investment, business purpose, wedding and honeymoon, or anything else. This provides you much greater flexibility than other popular assets.

If you wish to take an IRA withdrawal without paying taxes and penalty (if you are under 59-1/2) your situation will have to fit strict criteria. For instance, you can withdraw up to $10,000 if you are a first-time homebuyer. If unemployed, you can use IRA withdrawals to pay health insurance premiums.

Likewise, the rules about borrowing from or withdrawing from a 401(k) tax and penalty-free are quite restrictive. Some plans don’t allow loans at all. Many allow them only to pay for education expenses, prevent an eviction, pay for un-reimbursed medical expenses, or to buy a first-time residence.

Additionally, there’s a BIG catch to borrowing from your 401(k): you’ll have to repay the loan with after-tax dollars. If you are in a 24% tax bracket, for example, you’ll have to pay back $1,000 of pre-tax dollars with up to $1300 of after-tax dollars!

The flexibility of policy loans can be a real blessing—although it can also be dangerous if you are prone to over-spending. Some general rules of thumb to help you decide whether or not to borrow:

First and foremost, your policy should act as your emergency fund. Therefore, you should not borrow an amount that would deplete your cash availability below that level—6 months of living expenses or whatever that is for you—unless it truly is an emergency.

Beyond the emergency fund, the next purpose of your cash value should be for opportunities, such as an investment property down payment, a business expansion or a cash flowing investment. Lump sums of at least $25k to $50k are often needed for good income investments.

Last and least—a policy can be used for consumer purchases such as cars or vacations, or even to fund a home remodel. However, this does not always make financial sense. Car loans are typically at lower interest rates, and often home equity lines can be used for home remodels—often at lower rates and sometimes even tax deductible.

When might it make sense to use a policy loan for a purchase?

  • You cannot qualify for a low-interest car or home equity loan.
  • You need to keep purchases off of your credit report (perhaps you are home shopping or trying to raise your credit score).
  • Your other option was a credit card. In many cases, a policy loan will have significantly lower interest.

Of course, it is always best not to borrow from any source for consumer purchases. We prefer to use policies to

  • expand assets
  • grow a business
  • increase cash flow
  • or protect a family from emergencies and loss.

3.  The interest rate is determined by policy.

Policy loans are typically offered as a fixed rate (6 to 8 percent at the present time, depending on the company and also when policy was originated) OR an adjustable rate. (If you already have a whole life policy, the policy determines which… most companies do one or the other.)

Adjustable interest rates are lower than fixed rates at the moment, but of course they are subject to change. Similar to many adjustable rate mortgages, a policy loan interest rate is typically declared annually or bi-annually based on a pre-determined index and margin.

4.  Policy loans are not typically taxable or tax-deductible, unless…

Funds from policy loans are generally not taxable as they are loans, not income. They are also generally not tax-deductible. However, there are few important exceptions.

First, if you have MEC—a Modified Endowment Contract, loans can be taxed. Single Premium Whole Life policies (SPWL) are, by definition, MECs. Traditional whole life policies can also become a MEC if you overfund the paid-up additions. (The company will alert you if you have done so and it can be corrected if corrected soon enough.)

Second, if you do not keep your policy in force, money borrowed against your policy may be classified as income and taxed. This is a BIG reason why we do NOT recommend using policy loans for income! This idea is sometimes sold as “tax-free income.” However, if too much is borrowed against the policy and never paid back, the interest on the loans can drain all equity from the policy. Eventually that can even “collapse” the policy. You never want that to happen—so pay back your loans! If you are unable to do so, just take a withdrawal to pay back the loan. It will permanently reduce the size of your policy, but it will stay in force!

Third, interest usually not tax-deductible. However, if you are borrowing for a business purpose, it may be possible to set it up that way. (Consult your tax advisor on this.)

5.  You decide the repayment schedule

With most loans, the repayment schedule is pre-determined and often monthly. If you do an IRA rollover, the money must be paid back (or rather, put into a new IRA) within 60 days!

With whole life policy loans, you can pay back the loan on your own schedule. Some good ways to do that:

  • Interest only payments (until you have funds to repay principal).
  • Principal plus interest. If the policy loan is taking the place of a higher interest “loan” such as credit card debt or equipment lease, we suggest you pay back your policy loan with the same (or even higher) payments.
  • Monthly income from investments. If you use your policy to purchase a rental property or bridge loan, you can use monthly cash flow to repay the loan. In time, you’ll repay the loan and still have the asset!
  • Lump sum payments. This can work well for investors who use their policies to fund real estate rehabs or other investment projects that produce a lump sum profit when a project is complete. (And it’s nice not to have to make monthly payments in the meantime!)

Warning: as noted in point #4, do not borrow big loans and simply let interest accumulate year after year! Unless you have a lot of equity in your policy or are very elderly, this strategy can backfire.

6.  No, you aren’t “paying yourself interest.”

This is a major misconception (or perhaps miscommunication) in some “pro-whole life” circles. Confusing language is sometimes used that suggests you “pay interest to yourself” or “recapture all of your finances charges.” That’s not correct.

It’s true that you don’t pay interest to a bank as you might for a credit card, car loan or mortgage. But you still pay interest when you borrow against your policy. You pay it to the life insurance company—not yourself! You may pay LESS interest than you would with a credit card, therefore allowing yourself to save the difference… but the interest charged on a policy loan doesn’t go into your pocket.

You don’t “pay interest to yourself” with a policy loan any more than you “pay taxes to yourself” when your tax dollars fund roads, schools or parks that you use. (I.e., there may be a bit of truth in each case, but the wording is not helpful.)

7.  Life insurance can make your investments better!

Those who say “the returns of whole life are lousy” don’t understand how to use life insurance. And there are two things whole life critics often miss.

First, cash value is NOT an investment strategy; it is a savings vehicle. And when compared with long-term with other savings strategies—savings accounts, bank CDs and money market accounts, etc.—life insurance tends to earn far more—often several times more! (While savings accounts are paying one to two percent, internal rates of return for whole life policies are currently around 4 percent—net.)

Second, you can generate impressive profits by using your cash value to pursue opportunities, make investments, and expand your assets.

Many businesses have been started or assisted with money from whole life insurance, including Disneyland, J.C. Penney’s, Foster Farms, and Pampered Chef. (Learn more in “The Surprising Business Financing Secret of Top Entrepreneurs.”)

Cash value life insurance is also very powerful when paired with real estate investing. There is a case study my husband, Todd Langford, shares that shows how using a policy loan can make a good real estate deal even better! By using the leverage of a mortgage plus a policy loan, you can actually increase your rate of return. You can read it here: “How do I tell if my real estate deal is a good one?” or watch a presentation below:

As you can see, leveraging your life insurance to invest can be a savvy strategy!

New resources coming soon…

In the next month or so, we’ll be releasing a new book, Busting the Real Estate Investing Lies. In it, my co-author Jimmy Vreeland and I detail how pairing whole life insurance with real estate investments can generate powerful profits—while giving your family tremendous financial certainty!

We will also be expanding the available languages for existing titles (more on that next week.) And next year, look for our next release: Perpetual Prosperity: Using Family Banking to Grow and Keep Generational Wealth with co-author Kate Phillips. This will be a meaty book for families who want multi-generational “Family Banking” strategies—with many wise lessons gleaned from the affluent.

We’ll alert our subscribers when these are available. If you don’t already receive our weekly “Prosperity on Purpose” email newsletter, sign up to receive that and other helpful resources—on us!

3 thoughts on “7 Things to Know about Life Insurance Loans”

  1. Pingback: Whole Life Insurance: A Firm Financial Foundation |

    1. Hi Bill, that’s a complicated question and we will soon have a rather lengthy book coming out that addresses this on a bit simpler level. (I see you are already on the list to receive it.) A short answer: We recommend multi-generational strategies in which older generations save for the next through life insurance. Often, an older generation will own policies on children and/or grandchildren. There will only be ONE owner of a policy, but the policyowner can choose to lend money to younger generations to help them obtain education, buy a home, or even start a business. It is also possible to have a family trust that can own (or even be the beneficiary of) life insurance policies. That really depends on the family, as communication and cooperation are important. Hope that helps!

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