Spelling Out the Benefits, the Dangers, and the Confusion of Life Insurance Loans
Life comes at you fast.
One moment you’re signing up for student loans and the next you’re investing in your family’s future by pursuing a life insurance policy. Life can require you to make fast financial moves to secure your (and your family’s) future. Some of those moves may require a lot of cash — and fast.
Borrowing from your life insurance may sometimes be your last-ditch effort. In this case, it is necessary to have a clear understanding of life insurance loans and to also know any possible alternatives.
This article aims to explore the, sometimes complicated, details of taking out a life insurance loan so that you can be financially aware of the risks, benefits, and alternatives.
Table of Contents
Can You Borrow From Life Insurance?
You can borrow from your life insurance policy. However, life insurance loans are only available on permanent life insurance. The reason for this being is that only permanent life insurance policies, like whole or universal life insurance, have a cash component.
Life insurance policies, like term life insurance, do not have a cash component so there is nothing to borrow against.
Life insurance policies that can be borrowed from include:
Whole life insurance: Most common type of life insurance; the cash value (which is essentially like a savings account) earns interest over time as long as you pay immutable premiums
Universal life insurance: A flexible policy that allows you to scale how much you pay for premiums over time.
Variable life insurance: A life insurance policy that pays your family out a specific value at the time of your death, while allowing you to invest specific funds before you die.
What Is a Life Insurance Loan?
A life insurance loan is a loan that can be taken out against the death benefit and cash value of your life insurance policy.
The main reason a life insurance loan is different from other loans is because you’re not borrowing money from an establishment — you’re borrowing money from your future self (and your family).
The purpose of a life insurance policy is to provide a safety net for your family when you pass away. It provides support for expenses like:
Familial living expenses
Borrowing against this money could leave the potential for financial consequences to befall your family. So why borrow from the future of your loved ones, when you could advance money that is already yours?
You know that your employer pays out your unused Paid Time Off (PTO) once you leave your job or retire, but what you don’t know is that you don’t have to wait to access those funds.
Sorbet offers an easy way to advance your unused PTO. Tap into a well of unused compensation by advancing your PTO today. Getting paid is sweet, getting paid early is sweeter. Calculate your estimated PTO payout at termination to see how much money you could advance today.
How a Life Insurance Loan Works
As you pay the premium on your life insurance, it makes contributions toward three things:
Your death benefit
Your insurers’ costs and profits
Your cash value
When you borrow from your life insurance policy, you are borrowing from the cash value. The amount you can borrow is dependent on how much your cash value has accumulated. Most people rationalize advancing their cash value while they are alive, because once you pass — the accrued cash value of your life insurance policy reverts to your insurer.
How different policies accumulate cash value over time:
Whole life insurance: Cash value accumulates based on a pre-fixed formula determined by the insurance company
Universal life insurance: Cash value accumulates based on current interest rates and investments
Variable life insurance: Cash value is invested into a subaccount and the accumulation relies on the performance of the investments
How much money can you borrow from a life insurance policy?
Depending on your policy provider, you can borrow up to 90-95% of your cash value. Let’s say you have a policy with a cash value of $50,000. If your policy allows you to borrow 90% of that total, you will be taking out a $45,000 loan.
How soon can you borrow from a life insurance policy?
A cash value must first be built before you will be able to borrow from your life insurance. How quickly that money is built depends on several factors, like policy type. For example, whole life insurance builds cash value at a fixed rate. Whereas, variable and universal life insurance policies use cash value as an investment and its growth is dependent on how well those investments perform.
Typically, cash value does not accrue for at least two to five years. However, in the earlier years of your policy, a higher percentage of your premium will go towards cash value.
In the later years of your policy, the percentage of your premium that goes towards cash value will go down. This is because it costs insurance companies more to insure us as we age. So the portion of the premium that covers insurers’ costs and profits increases over time.
You are not required to pay back a life insurance loan. You will, however, be required to pay interest on the amount of the cash advance that was borrowed.
Interest in Advance
Interest in advance is when the insurance company charges interest on an insurance policy loan for the full year. If you borrow from your life insurance in the middle of a policy year, the interest will be charged for the remainder of the policy year when the loan is taken out.
Interest in Arrears
Interest in arrears is the interest charged at the end of the year. This type of interest accumulates daily. The interest accrues as soon as the loan is taken out. So, if you repay your loan in the middle of a policy year, your daily loan interest would decrease, therefore decreasing the loan interest due at the end of the year.
Are Life Insurance Loans Based on a Fixed or Variable Interest?
The interest rate on your life insurance loan can be fixed or variable, it all just depends on your insurer and policy type. Fixed insurance rates are guaranteed, so you know how much interest will be due at the end of the year before you even sign off on the loan. Variable interest rates can change over time.
Reasons for Borrowing From Life Insurance
Typically, when people borrow against their life insurance policy they are not borrowing for “fun money.” The money is not sought for indulgence, but instead, for survival.
Valid reasons for borrowing from life insurance include:
You need to quickly pay off high-interest debt.
Your credit score is not good enough for a bank loan.
Your family no longer needs your death benefit.
It would be safer to use your policy as collateral (as opposed to your home).
When considering loans, it’s always in your best interest to go for the safest, easiest option.
Most people don’t know that they can access their unused PTO through Sorbet. Why borrow from banks or against your life insurance policy when you can activate the earning power of your unused paid time off benefits?
Advantages and Disadvantages of Borrowing Money From Life Insurance
Your life insurance policy exists to ease the financial burden of your passing off of your family. Borrowing money from your life insurance policy may endanger these funds.
If you need to borrow money from your life insurance, you should know:
How your policy works
How to borrow from life insurance
All of the details of the loan
The rewards of borrowing from your life insurance policy can include:
No taxes: Policy loans are not considered taxed income.
No credit impact: Unlike borrowing a loan, there is no negative credit impact when you borrow from a life insurance policy.
Little repayment restrictions: You do not have to pay the loan back on a scheduled repayment plan. However, interest will continue to accrue until the loan is paid off.
Low-interest rates: Policy loans have lower interest rates (6-8%) than banks or credit cards. According to the Federal Reserve, the average interest rate for a two-year bank loan is 11.25%, as opposed to 20.40% which is the average credit card interest rate.
Cash value will continue to grow: Since your cash value is only used as collateral, it will continue to grow in interest so long as your policy continues.
Borrowing from your life insurance does not come without its consequences. The disadvantages of taking out a life insurance loan may include:
Risk of a reduced payout: If the loan and accrued interest are not paid, the total will be subtracted from the death benefit.
Risk of losing coverage: If the loan balance exceeds the cash value, your policy may lapse and you will lose coverage.
Risk of tax penalties: If your policy lapses before your loan is repaid, your loan will be reclassified as a withdrawal and you will be charged income tax on the amount you borrowed.
Accumulation requires time: It may be years before your cash value accumulates enough to be borrowed against.
How To Borrow From Life Insurance
Life insurance loans have a reputation for being confusing. To avoid any pitfalls from borrowing from your life insurance, it is necessary to have a holistic perspective of the process.
Understand Your Options Before Borrowing
Life insurance loans can alter the course of your end-of-life and after-life planning. Bad financial decisions often rear their ugly heads at the most inconvenient times. By having a thorough understanding of your options before borrowing, you can avoid leaving your family with financial burdens imposed by your passing.
So carefully research your policy and ask your policy insurer any questions that might arise before making this financial move. In addition, you should:
Verify your policy type
Calculate your policy’s cash value
Discuss the policy terms, interest rates, and repayment
Heavily weigh your alternatives
Whether you need the money to make house repairs or cover the cost of an expensive necessity, borrowing from your life insurance is not risk-free. It would be in your best favor to consider other loan alternatives before making a final decision.
Sorbet is the new loan alternative solution that maximizes and advances the earning potential of your unused PTO.
Sign-up is easy and flexible. Find out how much your unused PTO is worth in minutes. There are no hard credit checks, and if you decide Sorbet isn’t for you — no worries! Our offer is commitment-free, you can change your mind anytime.
How To Take Out a Life Insurance Loan
The process of taking out a life insurance loan is simple.
You’ll likely be required to fill out and submit a policy loan request, either online or on paper. Some insurance companies may even allow you to apply over the phone.
If you cannot find the right documents, you should be able to call and ask your insurance agent. There are no credit checks and no income verification requirements. You may only be asked to confirm your identity.
Do You Have To Pay Back Money You Borrow From Life Insurance?
Life insurance loans are not structured like the average loan.
You won’t be hounded for repayment or placed on a strict payment schedule. One of the benefits of a policy loan is that you do not need to make repayments.
You do, however, need to make payments on the charged interest of the loan. If the interest on your loan is not paid, it is added to your total balance. If you do not pay interest or make repayments on your life insurance loan, two things may happen.
If your loan balance exceeds the cash value of your policy, your policy will lapse and your death benefit will be forfeited. You will also be required to pay income tax on the amount you borrowed.
If you do not make repayments to resolve your loan before you pass, the amount of the loan plus interest will be confiscated from your death benefit.
How To Monitor and Pay Back Your Life Insurance Loan
Consider these tips when monitoring and repaying your policy loan:
Find out all the necessary information you need for repayment. This info can be found in your loan statements.
Keep track of your interest to avoid negative financial consequences like policy lapse. This means making minimum payments on your interest so your loan does not exceed the cash value of your policy.
Set up automatic payments.
Make a plan and stick to it. For your beneficiaries to receive the full death benefit, you’ll need to do more than repay just the interest. Talk to a financial advisor to make a repayment plan that sets you on the right track for repayment.
Inform your beneficiaries. Any unpaid portion of the loan will be deducted from the death benefit. Inform your loved ones of your insurance loan so that they will not be blind-sided by a reduced death benefit.
Don’t steal life insurance funds from your future. Don’t go into debt with traditional bank loans. Don’t harm your credit with unpaid credit card bills.
You’re already going to get paid for your unused PTO. Use Sorbet to advance these funds to pay for emergencies — or even indulgences.
Sorbet PTO Advance: A Superior Alternative to Borrowing From Life Insurance
When you turn a blind eye to all of the possible financial consequences, borrowing from your life insurance policy seems like a pretty sweet deal. But just because the possible negative outcomes are in the distant future, it doesn’t mean you're not at risk.
There has to be a way to access potential funds without posing a great risk to your financial future. Well, we’re happy to say there is — with Sorbet.
Get a sweeter deal, without stealing from your family’s future. Advance your unused paid time off benefits using Sorbet. You’re going to get paid for your unused PTO anyway. So why wait to use those funds?
Access your unused PTO early.
No hard credit checks.
Get paid in 1 to 5 business days.
You pay your cash advance back whenever you get your paid time off payout.
And what does it cost?
Just a few minutes of your time to calculate your unused PTO and sign up!