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Published: Dec 05, 2022 10 min read
A person borrowing a piece of puzzle depicting a lifesaver
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Permanent life insurance policies, such as whole life insurance, build up cash value from which you can make withdrawals. You can also use your accrued cash value as collateral to borrow from the policy.

Read on to learn more about borrowing money from your life insurance policy.

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Can you borrow from life insurance?

Some types of life insurance policies allow you to take out cash loans at any time for any reason.

  • With Permanent life insurance policies (whole life and universal life) a portion of your monthly premium payments go toward a cash value component that grows over time. One way to tap into that cash value is by borrowing against the accrued amounts (you can typically borrow up to 90%). Keep in mind that, depending on the policy, it can take up to 10 years for you to build enough cash value to borrow against.
  • Term life insurance, on the other hand, does not accrue cash value throughout its duration. Compared to permanent life insurance, a term policy offers lower premiums (as much as ten times less than permanent life insurance) but expires after a set amount of time — typically between 5 to 30 years.

Even if you can’t afford the higher premiums of a permanent life insurance policy right now, there’s no need to worry. Some of the best life insurance companies offer the option to convert term life insurance into a permanent policy at a later date.

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Borrowing against life insurance

There are several ways to use the cash value component of your life insurance policy. As mentioned above, one such way is to borrow against the policy, which uses your accrued cash value as collateral.

If the loan is not repaid by the time the death benefit is paid out, any owed amounts (loan interest included) will be deducted from the payout. For example, a $50,000 life insurance policy with an outstanding loan balance of $10,000 would only pay $40,000 upon the policyholder’s death.

On the other hand, the main risk of a life insurance policy loan is that it may lapse if your loan balance plus interest exceeds the cash value. If your policy lapses, any loan amounts previously taken out may be considered income by the IRS and, therefore, taxable.

Thankfully, many insurers offer ways to avoid a policy lapse, typically by providing a grace period for late payments. The best whole life insurance companies will actively work with you to keep your policy from lapsing.

The easiest way to ensure your policy stays in effect after taking out a loan is to make periodic interest payments. This way, the outstanding loan amount stays the same even if you never pay back your loan, and your policy still has some cash value that can be paid out in the event of your death.

Pros and cons of taking out a life insurance loan

  • They can be taken out at any time, for any reason
  • They don't require credit checks or any additional documentation for approval
  • May feature lower interest rates than a standard bank loan
  • They don't affect your credit score, since you're essentially borrowing from yourself
  • You are not required to pay back the loan (interest will continue to accrue, though)
  • You may be taxed on the borrowed cash value if you don't pay back the loan
  • The loan accrues interest
  • If the loan balance grows too large and isn't repaid, your death benefit may decrease

Aside from taking out a policy loan, there are other ways of accessing your policy's cash value:

Paying premiums

Most insurers allow policyholders to use their accrued cash value to cover premium payments. To do this, you’ll need to have sufficient cash value accumulation. You should also keep an eye on your available balance, as depleting the cash value would cause the policy to lapse.

Direct withdrawal

Depending on your policy, you may be able to take withdrawals from your policy’s cash value account. If the amount you are withdrawing is lower than what you’ve paid in premiums so far — what is known as your policy’s cash basis — then it is considered tax-free.

If, on the other hand, your withdrawal exceeds your basis in the policy, you may be required to pay taxes. To verify whether a withdrawal will impact your taxes, consult a financial advisor.

And as with policy loans, withdrawing funds from your cash value can reduce your beneficiaries’ death benefit payout.

Policy surrender

Finally, you can voluntarily cancel or "surrender" your policy. Although you may receive some money from this option, it also means that you are forfeiting the death benefit payout to your beneficiaries.

When you surrender your policy, the insurance company returns the accumulated cash value minus any applicable fees and penalties. This means that, in some cases, the cash surrender value may be less than the accumulated cash value.

Since a surrender is simply a voluntary cancellation, you can do this at any time. There are no special requirements or prerequisites for you to do so.

As an alternative to surrendering your policy, you can also consider the pros and cons of life settlement, which involves selling your life insurance policy to a third party who will collect the death benefit once you die.

What is the cash surrender value of life insurance?

Cash surrender value refers to the money an insurer pays the policyholders when they voluntarily cancel their insurance coverage before an insured event occurs (or before the policy reaches maturity).

The cash surrender value of your life insurance policy is the accumulated cash value minus any applicable fees and penalties. This includes accrued interest, but not previously withdrawn amounts.

If your policy’s cash surrender value is less than what you’ve paid in premiums until that point, the money you receive is tax-free since it’s considered a sort of premium refund. Note that you may also be responsible for taxes on earnings accrued in the cash value account.

How to calculate cash value surrender of life insurance

It is important to note that your cash value surrender amount is not the same as your policy’s death benefit or what you’ve paid in premiums.

As previously mentioned, your policy’s cash value at the time of surrender is the total accumulated cash value minus any fees, penalties or previously withdrawn amounts.

For example, let’s say that your policy accumulated $10,000 in cash value and you want to surrender it and cash out. However, the insurance company charges you a 15% penalty for early cancellation.

Your policy’s cash value at the time of surrender would then be:

$10,000 - $1,500 = $8,500

You should keep in mind that early cancellation fees decrease over time. This means that even if your policy has a high penalty — between 10% and 35% — for canceling your policy in the first year, that number will decrease over time until it no longer applies (generally after a decade, depending on the policy).

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Whole life insurance cash value

A whole life insurance policy with a cash value component can be compared to a retirement investment account. Similarly to a retirement investment account, the cash component of your policy is invested and accrues tax-deferred interest.

On the other hand, these policies are fairly expensive and the cash value earnings you receive can be pretty low compared to other investment vehicles. In fact, due to a recent whole life insurance tax change, the range of return for whole and universal policies will decrease in low interest rate environments. This, however, may be a positive — and it won’t apply to existing policies.

You can also use this type of life insurance as collateral for different types of loans, including personal loans, small business loans and mortgage loans. Note that this is not the same as borrowing from a life insurance policy, but a way of using your life insurance policy to secure a loan.

Borrowing from life insurance FAQ

What is cash value life insurance?

Cash value life insurance refers to life insurance policies that accumulate cash value over time. Only permanent life insurance policies like whole life, universal life and guaranteed life can accrue cash value. These policies generally have much higher premiums, as a portion of your premium payment is used to fund the death benefit while the remainder gets deposited into a cash value account tied to your policy.

Does term life insurance have a cash value?

Term life insurance has no cash value. These policies pay out a death benefit if the insured dies within a given term, usually between one to 30 years. If the insured outlives the term, the policy simply expires.

What type of life insurance gets immediate cash value?

Although permanent life insurance policies start to generate cash value right away, cash value growth varies by policy type and it could take years before there are enough funds for you to borrow or withdraw. Additionally, some insurers will not allow you to tap into the cash value if you've held the policy for less than ten years.

Can you cash out a life insurance policy?

If you have a whole life, universal life or guaranteed life insurance policy, you may be able to either borrow against your policy or "surrender" it so you can receive part or all of its cash value before death. The amount you'll receive will depend on how long your policy has been active and how much you've paid in premiums up until you cash out.

Summary of Money’s how to borrow against life insurance

Permanent life insurance policies (whole life, guaranteed life, universal life) have a cash component that accrues interest. You can withdraw directly from the accumulated cash value or take out a loan using the policy as collateral. The policy can also be “surrendered” or voluntarily canceled to recover all or part of the accumulated cash value.

Although borrowing from your life insurance policy is an easy way to access cash, it does have its risks. Life insurance policy loans must be monitored to prevent accrued interest from depleting the cash value altogether, which would cause the policy to lapse.

Key takeaways:

  • You can borrow against your life insurance using your accrued cash value as collateral
  • Loan amounts are not considered income by the IRS and are tax-free
  • You are not obligated to pay back the loan, but it still accrues interest
  • If the loan balance exceeds the total accrued cash value, your policy may lapse
  • A lapsed policy means that your loan is treated as income and is now taxable
  • Outstanding loan amounts are deducted from the total death benefit payout