Whole Life Insurance Loans Explained

Whole life insurance is a type of permanent life insurance, which means the policy covers you for the duration of your life. The death benefit (i.e. the amount of money your beneficiaries will receive when you die) is guaranteed to pay out when you die, which differs from term life insurance which will only pay out if you die during the designated term.

When you pay for a whole life insurance policy, you get two primary benefits. The first is the death benefit that passes tax free to your beneficiaries. The second is cash value. Cash value is an account that grows tax deferred and grows at a rate guaranteed by the insurance company.

When you pay your premium, your money will go towards administrative costs, the cost of your insurance, and your cash value account. The insurance company makes investments into what is called their separate account which is how the cash value of your policy grows.

Depending upon the structure of your policy, your cash may grow fairly quick or fairly slow. The good news is that you get to access this cash value while you are still alive. You can use this cash value in a variety of ways, but one of the most common is to take policy loans against your cash value.

Whole life insurance loans are a type of collateralized loan. It is very important to understand that you are borrowing against your policy, and are not taking a withdrawal from your policy. For example, say that you had built up $100,000 of cash value in your whole life policy.

You call up your insurance company and ask for a loan against your policy for $50,000. Your insurance company checks the amount of cash value you have and then asks where you want the money to be sent. Here is a quick quiz for you.

Does the $50,000 leave your cash value account? Nope. Your $100,000 stays in your cash value account and continues to earn interest. The $50,000 is given to you by the insurance company. So, what is the collateral for this loan?

Your death benefit. If you have any outstanding policy loans when you pass away, the amount of those loans will be subtracted from your death benefit. Don't get too hung up on all the details as we will explain them more in depth as we go on.

The point here is that you can get a tax free loan by borrowing against your whole life policy. The insurance company does not care what you use it for. There are no credit checks and no application process. Since it is your money in the policy, you will always be able to access it as long as you have the money available in your cash value account.

In short, no. Your insurance company will typically charge you interest that is slightly higher than what your cash value earns when you use a whole life policy loan. For example, say that you have $100,000 in your cash value account that currently earns 3%.

Your insurance company may charge you 4% a year in interest for a $50,000 policy loan. Although you are charged interest with a whole life insurance loan, it can still be advantageous to use one in certain circumstances. For example, say that you need a new car and decide that financing the car is better than paying cash.

You shop around at various credit unions and banks for competitive financing. The best rate that you are able to find is 7%. However, since you have a whole life policy, you can simply borrow against your cash value at 4% (as an example) to purchase the car.

In this scenario, you would essentially become your own bank. Your whole life policy allows you to obtain cheaper financing than anything else that is available to you and you simply pay your policy back just as you would with a traditional auto loan from a bank.

This section can make whole life insurance policy loans confusing as the following information seems counterintuitive. Technically, you never have to pay back the loans you take against your policy. But, it's a loan so how does that work?

Earlier we mentioned that whole life insurance loans use your death benefit as collateral. Any outstanding policy loans will be subtracted from your death benefit when you pass away. For example, say that you have a whole life policy with a $1 million death benefit.

Imagine that you are older and have retired. During your retirement, there were some rough years in the stock market that negatively impacted the value of your 401k and Roth IRA. Due to this, you took a few small policy loans against the cash value in your whole life policy to supplement your income.  

Say that you never paid back these loans and that the loan amount plus accrued interest was $250,000 when you died. Instead of your beneficiaries receiving the full $1 million death benefit, they would receive $750,000 (the original death benefit minus the outstanding loans).

Although you don't technically have to pay back the loans, you probably should. As mentioned before, your insurance company will charge you annual interest. If you do not pay back the interest, it will be added to your balance and continue to accrue interest the following year.

This is why it is usually a good idea to pay at least the interest on your loan each year. If your outstanding loans exceed your death benefit, your policy can blow up and you can face tax consequences. However, the advantage to a whole life policy loan is that you do have flexible repayment options.

You get to choose when and how you get to pay back the loan which is a unique feature. If you have a mortgage, your bank expects your mortgage payment each month. However, with a whole life policy loan if you miss a payment one month you will be okay.

The exact amount of money you can borrow will vary by insurer, but it is typically up to 90% of your available cash value. All your insurance company cares about is that you have the money. They do not care what you intend to use the money for.

The good news is that you cannot be turned down for a loan if your cash value account has the money available. This is a contractual obligation of the insurance company, which means that you will be able to access your money whenever you want, for whatever purpose you want.

The answer is that it depends. Whole life insurance is a complex product and is not suitable for everyone. However, for some individuals, the product is suitable for them according to their individual needs and goals. The point of whole life insurance policy loans is to have access to capital.

Maybe you are looking to start a business, make an investment, upgrade your home, buy a car, supplement your retirement income and more. Since insurers guarantee you will have access to your money, whole life policy loans are a way to ensure you will always have access to your money when you need it.

You are not dependent upon a bank or other financial institution to give you money when you need it as your whole life insurance policy makes you the bank. With all that being said, it is vital you understand all the ins and outs, and pros and cons of whole life policy loans before using one.

Whole life insurance policy loans can be a great addition to a financial plan, but only if you understand what you are doing. We highly recommend speaking to a competent life insurance agent who has your best interest in mind to see if a whole life insurance policy and subsequent policy loans make sense for you.

The bottom line is whole life policy loans allow you to borrow against the cash value in your policy. Your insurance company will typically charge you an interest rate on these loans that is greater than what your cash value earns.

You don't technically have to pay back these loans as your death benefit serves as collateral, but it is best to make a repayment plan as the policy can blow up in your face if your outstanding loans exceed the amount of death benefit coverage.

You can typically borrow up to 90% of the cash value in your policy depending on your insurer, and you will never be turned down for a loan if you have the money available. Whole life insurance loans are not for everyone so make sure to speak with a competent life insurance agent before using one.