It’s common for people to purchase life insurance policies as a way to provide financial safety for their family when they die. However, some life insurance policies like Indexed Universal Life (IUL) can also provide living benefits such as being able to borrow money from the company using your policy’s cash value as collateral.
It always makes sense to understand the pros and the cons to determine the answer to “Should I borrow against my IUL?” before calling the insurance company and asking for a loan.
Can I borrow some of the cash in my IUL?
First things first. To borrow against your life insurance policy, the policy must be the type of life insurance that has a cash-value account. Term insurance will not work.
Your policy must be a cash value policy like Whole Life insurance or Universal Life. Most people that own cash value life insurance purchase it because of the cash value component. This means that the policy becomes an asset and like with any asset, you can use the asset value as collateral for a loan.
However, before you can take out a loan against your policy, there must be enough funds in the cash value account to satisfy the company’s collateral requirement.
In other words, you can’t borrow $2,000 from an insurance policy when the cash value account is only $500.
There are huge advantages to borrowing against your life insurance cash value versus borrowing from a traditional lender or using a credit card.
- Borrowing from your IUL insurance policy can be done for any reason.
- There is no credit check.
- You can pay back the loan how you see fit, or not pay it back at all
- The cash-value that you have collateralized will continue to earn tax-deferred interest.
- Your cash-value will continue to earn dividends if it’s a participating policy.
- The interest rate is generally lower than what a traditional lender charges.
When’s the best time to borrow from my policy?
As long as you have sufficient cash value in your policy, anytime is a good time to borrow against your policy. In fact, your insurance policy can become a personal bank that you can use during your lifetime and recapture interest that you would pay to a traditional lender or credit card company.
For example, if you’re planning to buy your teenage son or daughter a used car for their 17th birthday, it would be much easier and quicker to take out a policy loan than to ask your banker to loan you the money. Your IUL policy will continue to earn tax-deferred interest that could substantially offset the interest that your insurance company charges. You repay the loan or your terms rather than the bank’s terms.
In fact, even if you have the cash available to purchase the vehicle, you could be better off taking a loan against your insurance policy for the purchase. Your policy continues to grow and your cash is free for use on other expenditures.
Plus, there’s no credit check or loan application when you borrow against your insurance policy.
There are many people that own cash-value life insurance for the sole purpose of using it to provide a stream of tax-exempt income during retirement and consider the death benefit secondary.
Additionally, as you get closer to your pre-determined retirement age, you would likely need a lower death benefit for surviving loved ones, so why not take that money for retirement? This type of retirement planning is commonly referred to as a LIRP or Life Insurance Retirement Plan.
How can I borrow from my IUL?
Taking a loan (notice I didn’t say “asking for a loan?”) is quick and easy. First, call the company and find out what funds are available and if sufficient for your purpose, let the representative know that you’d like to borrow against the available funds.
Since this is not a traditional loan, there is no underwriting process or credit check, only a one-page form that you can complete online and electronically sign for the loan.
You can set up a repayment schedule or not. It’s your call. The insurance company will set the interest rate which you can pay monthly or annually.
If you decide not to pay the loan or loans back, your insurance company will simply deduct the amount of outstanding loans and interest from the death benefit when you die.
Moreover, if you decide to take loans as a retirement income stream, you’ll not have to worry about any tax liability because loans are not taxable.
What are the pros and cons of borrowing against my IUL?
It’s always a good idea to check the pros and cons of borrowing against a cash-value life insurance policy:
Pros:
- You can borrow against your insurance policy’s cash value for any reason
- There are no qualifiers other than having sufficient cash value for collateralizing your loan.
- Your loan is not reported to credit bureaus
- No set repayment schedule (unless you want one)
- Interest rates are generally lower than rates from a traditional lender
- Your cash account continues to earn interest and dividends (depending on the type of policy)
- No repayment requirement
- Allows you to recapture interest you would have paid on a traditional loan
Cons:
- If you died before paying off outstanding loans, your death benefit would be reduced by the sum of the outstanding loan(s) and interest.
- Unless you have purchased a single premium insurance policy, it can take time before your cash-value grows enough to be used as collateral.
- You would likely have a tax-liability if you borrow from a policy that is a modified endowment policy
- “Overloan” consequences. If your loan(s) against your life insurance exceed 90% of the policy cash-value, your policy could lapse. This can be overcome by purchasing a policy with an overloan protection feature.
Frequently Asked Questions
How soon can I get a loan from my IUL policy?
As soon as the first year you buy your policy. You will only be able to access approximately 90% of the cash surrender value. You can speed up the process by paying more than the minimum required premium.
Does borrowing from my IUL policy affect my credit score?
Since borrowing against your IUL cash value does not require a hard credit inquiry, it will not affect your credit score.
Is my cash-value account frozen when I take out a policy loan?
Since the money you borrow is not withdrawn from your cash-value account, it will continue to earn interest (and dividends if a participating policy). Additionally, the interest earned will help offset the interest the insurer will charge for making the loan.
Can I borrow against my life insurance at work?
Since insurance policy loans can only be made against cash-value life insurance and most employer-sponsored life insurance policies are Term Life Insurance, you would probably not be able to borrow against that policy.
