Can I Borrow from a Life Insurance Policy?
Borrowing from life insurance policies can sound like an attractive idea. But before you can, there are many things to consider, from policy options to limitations with borrowing. This article answers common questions about infinite banking and outlines everything you need to know about borrowing from life insurance policies.
What is life insurance?
Life insurance is a contract between the policyholder and an insurer. The policyholder pays a premium to the insurer to secure a sum of money (called a “benefit”) from the insurer when the policyholder dies. The benefit is intended to ensure financial security for the policyholder’s dependents after their death.
What are the different types of life insurance?
There are many types of life insurance. However, two of the most common ones are term life insurance and permanent life insurance. Permanent life insurance also has subtypes.
- Term life insurance lasts for a pre-set period, and policyholders are limited to waiting for death to have access to their money. However, term life insurance policies are often cheaper. Standard term-life insurance lengths are 5, 10, 15, 20, 25, and 30 years.
- Permanent life insurance is a term used for policies that last a lifetime. These policies are more expensive but offer more flexibility and control to policyholders. Common types of permanent life insurance include variable, universal, and whole life insurance.
What is infinite banking?
Whole life insurance, particularly dividend-paying whole life insurance, has a fixed benefit (cash value) that grows tax-free for the duration of the policy and creates a fund that can be borrowed against. Borrowing money from a whole life policy can accrue interest, but the policyholder captures the interest. This is the process that occurs within banks and other financial institutions.
Can I borrow from a term life insurance policy?
Borrowing from term life insurance policies is typically impossible because these policies do not build cash value. Insurance companies use cash value as collateral when a loan is taken from the policy. Without cash value, it is not possible to take out a loan.
What policies can be borrowed against?
Any permanent life insurance policy can be borrowed from. However, certain types are better suited for infinite banking.
With variable life insurance, the cash value is invested into sub-accounts (e.g., equities, bonds, or indexes). Therefore, cash value depends on the sub-accounts performance and cannot be maximized.
With universal life insurance, cash value increases by investing funds into indexes (or keeping it within the policy to earn a low, fixed rate of return). Therefore, like variable life insurance, cash value also depends on performance.
Cash value in a whole life insurance policy is not dependent on the performance of accounts, making it ideal for infinite banking.
How to grow cash value in a whole life insurance policy?
With whole life insurance policies, the policyholders pay monthly premiums. The premiums pay for the death benefit and miscellaneous fees (e.g., administration fees). Any remainder from the premium payment is considered cash value. Cash value is guaranteed in the initial policy but can be improved through participating whole life insurance or by paying more than the premium payment.
Participating whole life insurance allows for additional growth through dividends. A dividend is a sum of money granted to shareholders from a company’s profit or surplus. Purchasing dividends can grow cash value but may be riskier and involve higher premium rates.
Policyholders can also add value through paid-up additions riders. A paid-up additions rider is additional coverage bought using the money received from dividends.
How to borrow from whole life insurance?
Once enough cash value has accumulated in the policy, it can be borrowed against. Borrowing processes may differ from company to company, but the process is generally straightforward.
The policyholders contact their insurance company and let them know how much they want to borrow and where to send it. And the insurance company sends the money by check or transfer, typically within a few days.
When a loan is taken from a policy, the insurance company will charge the policyholder interest, which is added to the loan balance. And the policyholder can make payments when they like.
The policyholder captures the interest, and there is freedom when paying it back. However, there are some essential things to keep in mind:
- Interest will continue to accumulate until the loan is paid, so taking too much out without paying some back puts the policyholder at risk of exceeding the cash value. If this happens, the policy will lapse.
- Outstanding loan balance will be deducted from the death benefit when the policyholder passes away, which may reduce the amount of money given to the beneficiaries.
- Only some insurance policies allow the policy to grow at the same rate as if there was no policy loan, so that borrowing may affect the cash value growth.
How much money can be borrowed from whole life insurance policies?
A loan that exceeds the cash value within the policy cannot be taken out. Typically, policyholders can take out a loan of up to 90 percent cash value, but this depends on what is allowed by the insurance company.
When can money be borrowed from a whole life insurance policy?
Money can be borrowed from a policy if there is cash value, but it will likely take several years until there is enough cash value to make borrowing feasible. However, this time can be shortened by growing cash value through dividends or paid-up additions riders.
Pros and cons of borrowing from whole life insurance policies
Whole life insurance policies can be an excellent tool for financial freedom. There is a guaranteed rate of return, the cash value grows tax-free, and there are opportunities for additional growth. Policyholders have complete control over the insurance policies and flexibility to cater to personal needs. However, there are some pitfalls to borrowing from one’s insurance policy. These include:
- Large upfront and premium costs.
- Long wait time to accumulate enough cash value to borrow from.
- Withdrawing money from the policy while the policyholder is alive may reduce the death benefit.
- Not paying on time can cause a policy to lapse.
- Understanding the ins and outs of borrowing from a life insurance policy can be challenging for people not in the financial field.
Those willing to put in the effort that have the financial means to do so will likely benefit from investing in whole life insurance policies. And there are many resources and professional guidance available to help get you started.
Get Started with Infinite Banking
If you have a question about infinite banking or borrowing from a life insurance policy, contact us at Living Wealth for a free personal consultation.
You can also take our free introductory infinite banking course: Start here.
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