How Does a Life Insurance Policy Loan Work?
Certain permanent life insurance policies can build cash value over time.
Rather than withdrawing that money directly from the policy, a policyowner may have the option to borrow against the policy’s cash value.
The insurance company provides the loan and charges interest on the outstanding balance. Because the policy’s cash value serves as collateral, there is generally no traditional loan application or credit check.
However, borrowing against a policy can affect its cash value, performance and death benefit. That’s where understanding the type of loan becomes important.
Fixed vs. Participating Loans
With a fixed or standard policy loan, the portion of cash value associated with the loan may be treated differently for interest-crediting purposes. Depending on the policy, that amount may receive a specified rate while the insurance company charges a separate loan interest rate.
A participating or indexed loan may work differently. The cash value securing the loan can remain allocated to the policy’s indexed or other crediting strategy while interest is charged on the loan.
That creates an important distinction: the interest credited to the policy and the interest charged on the loan are not necessarily the same.
If the policy receives strong interest credits, those credits may help offset some of the loan cost. If the policy receives little or no interest credit, however, the loan interest continues to accrue.
Why the Difference Matters
Imagine a policyowner has accumulated significant cash value and takes a $50,000 policy loan.
With a fixed loan, there may be greater predictability in how the borrowed portion of the policy is credited and what the loan costs.
With a participating loan, that $50,000 may remain exposed to the policy’s crediting strategy. In a year with strong credited interest, that can work in the policyowner’s favor. In a year with little or no credited interest, the loan could become more expensive relative to the policy's growth.
Neither approach is automatically better. The impact depends on the policy, its loan provisions, interest rates, crediting performance and how long the loan remains outstanding.
Policy Loans Still Need to Be Managed
Policy loans can provide valuable flexibility, but they aren’t “free money.” Interest can accumulate, and an outstanding loan can reduce the policy’s available cash value and death benefit. If a loan becomes too large relative to the policy’s value, it may also increase the risk of the policy lapsing and potentially create tax consequences.
That’s why it’s important to understand exactly how a policy’s loan provisions work before accessing its cash value—and to continue reviewing the policy after a loan has been taken.
Here to Help
Life insurance can do more than provide a death benefit. If you have an existing policy and want to better understand its cash value, loan options or how it fits into your overall financial strategy, I’m here to help you review the details and make an informed decision.
Reach out today to schedule an appointment.
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