If you do not repay a loan against your permanent life insurance policy, you risk decreasing the death benefit your beneficiaries will receive.
Permanent life insurance has a cash value
Cash value is a unique feature to permanent life insurance policies. All permanent life insurance policies have death benefits as well as a cash value that grows on a tax-deferred basis. The big difference between the types of permanent life insurance policies is how they manage the cash value — in the insurance company’s portfolio, stock market, or annuities.
The initial years of a permanent life insurance policy are expensive compared to what you’ll pay in the future. “In the early years of overpayment, the cash value put inside the policy earns interest and you use that bucket of money to offset the cost of insurance when you’re older,” said Mark Williams, CEO of Brokers International.
Most people use the cash value to fund their retirement — paying themselves a monthly income when they stop working. Permanent life insurance can function as an investment and wealth-building tool.
| Types of permanent life insurance | Best for | Where is the cash value invested |
| Whole Life | Guaranteeing exact same premium for the life of the policy | In your insurance company’s portfolio |
| Universal Life | The flexibility to change your premium, death benefit, and cash value over time | In your insurance company’s portfolio |
| Guaranteed Universal Life | Flexibility of a universal life policy with guaranteed rates of whole life | In your insurance company’s portfolio |
| Indexed Universal Life | Like universal life instead of interest rates in fixed indexed market | Fixed index stocks and options |
| Variable Life | Investing your cash value in the stock market rather than your insurance company | Stock market |
| Variable Universal Life | The flexibility to change your death benefit, investing in the stock market rather than your insurance company | Stock market |
Taking a loan against your permanent life insurance policy
If you borrow money or take out a loan against your permanent life insurance policy’s cash value, you don’t pay tax on the loan, but you pay interest. The interest you pay is based on current market rates and can be fixed or variable depending on the type of permanent life insurance policy you have.
Williams said the loan is basically borrowing from the insurance company, using your policy as collateral. He noted the insurance companies will allow you to borrow money instead of making a withdrawal, which could trigger taxes.
A reason people get permanent life insurance is for the cash value and ability to get loans tax-free without using other assets as collateral. It can be used to pay for children’s college tuition, fund a business, or purchase a second home.
Quick tip: Term life insurance does not have cash value. Therefore, you will not be able to take a loan against a term life insurance policy.
What if I don’t repay a loan on my permanent life insurance?
Williams said you can pay the loan back or never pay it back and keep the policy until you die. However, he noted if you die with an outstanding loan, the insurance company will reduce the death benefit payable to your beneficiaries by the outstanding loan amount.
If you have enough cash value or dividends on your policy, you can use the dividends to pay back the loan. This depends on the type of permanent life insurance product you have.
If you want to cancel your life insurance policy and you took out a loan that you haven’t paid back, you’ll need to contact your insurance company to start the process to get cash surrender value. Cash surrender value is the money you’ll receive back when you cancel a permanent life insurance policy.
If you cancel your insurance policy while you still have a loan, you will receive the cash value minus the outstanding loan balance and any fees associated with canceling your policy. You will also have to pay taxes on the cash value received. Before surrendering your permanent life insurance policy, consult an accountant or tax professional about the tax implications.
Consult an expert before taking a loan on your life insurance
Permanent life insurance is more than a payout for your beneficiaries. It’s an opportunity to build wealth and fund your retirement through the cash value your policy accrues. If you’re considering taking a loan against your permanent life insurance policy, consult an accountant and financial advisor first.
Much depends on your current financial situation and goals. You want to understand any tax implications, the impact on your death benefits in case you don’t pay back the loan, and protecting other assets. This decision can’t be made in a vacuum because everyone’s needs vary. Involving an accountant and financial advisor can help you avoid making a decision that is not financially sound or advantageous for you.
You may be able to borrow against term life insurance with a rider
Term life insurance does not have cash value. However, return of premium, also referred to as ROP, is an optional add-on rider to a term life insurance policy. A “return of premium” rider returns part or all of the money you’ve paid on premiums if you haven’t used the policy once your term ends.
Some return of premium riders offer cash value as an add-on feature — this varies by insurance provider. State Farm says its return of premium has cash value that you can borrow during the term, but any unpaid balances decrease the death benefit. In this way, return of premium riders mimic some of the benefits of a permanent life insurance policy.
If you want a policy that doesn’t expire, accumulates cash value, and has a death benefit that you can increase over time, then maybe a permanent life insurance policy is what you’re looking for.
If you’re considering permanent life insurance, it’s wise to consult an accountant and financial advisor to determine which policy is best for you and the tax benefits and implications. It’s worth taking the time to find the best policy for you, because once you’ve signed on the dotted line, it’s a lot more difficult to make changes if you need to adjust your coverage.
Ronda is an attorney, writer, and entrepreneur. She is a contributing writer for the Huffington Post. Originally from Chicago, she has lived in Los Angeles and New York. She loves to travel and is passionate about education equity, especially for first generation college students.