Borrowing Against Whole Life Insurance: How It Works

This guide answers the most common questions about borrowing against whole life insurance.

Your whole life policy's cash value can be a source of funds when you need them. A policy loan is how you tap it.

Here is how borrowing works and what to watch.

Part of our complete guide: Whole Life Insurance: The Complete Guide.

Borrowing against whole life insurance: how whole life policy loans work

Once there is enough cash value, you can usually borrow against it. There is no credit check and no set repayment schedule. Interest accrues on the loan.

• Flexible: repay on your own timeline.
• Reduces the benefit: unpaid loans and interest are subtracted from the death benefit.
• Lapse risk: if the loan and interest grow larger than the cash value, the policy can lapse, which may create a tax bill.

Borrow from cash value: what is cash value?

Think of cash value as a reserve that builds inside the policy. It starts small and grows over decades. You can tap it through policy loans, but anything you borrow and do not repay reduces what your beneficiaries receive.

Whole life cash value growth is set by the contract, which makes it predictable. Participating policies may also earn dividends, which can add to cash value, though dividends depend on the insurer's results each year.

How life insurance is taxed

Life insurance death benefits are generally income-tax-free to the beneficiary. That is one reason life insurance works well for a goal like paying off a mortgage: the amount your family receives is generally the amount they can use.

There are exceptions. Interest paid on a benefit that is held and paid out over time can be taxable. Very large estates can owe estate tax, and a policy you own counts toward your estate. Policies that were sold or transferred for value can also lose some of the tax benefit.

Tax rules change and every situation is different. For anything beyond the basics, talk with a tax professional. We can explain how a policy works, but we do not give tax or legal advice.

What are whole life dividends?

Participating whole life shares some of the insurer's results with policyholders through dividends. You choose how to use them, and paid-up additions are a popular option for growing coverage and cash value over time.

When comparing policies, look at the contractual values separately from projected dividends. Projections are illustrations, not promises.

What if you miss a payment?

Life insurance only works if it is in force when it is needed. Premiums can usually be paid monthly, quarterly or yearly. Paying yearly can cost a little less overall.

If you miss a payment, most policies have a grace period, often about a month, when coverage continues. After that the policy can lapse. Some policies can be reinstated within a set time, but the insurer may ask new health questions.

Tip: Automatic payments from a checking account are the simplest way to avoid a lapse.

Why work with an independent agency

A captive agent works for one insurance company and can only offer its policies. An independent agent is appointed with several carriers and can compare them side by side.

That matters because carriers price the same person differently. One may be friendlier to a past health condition, another to tobacco users, another to larger coverage amounts. Comparing several gives you a better chance at a fair price.

You do not pay extra to use an independent agent. Agents are paid by the carrier you choose, and the premium is the same as buying from that carrier directly.

Whole life vs. term life

Many people use both: term for large temporary needs and a smaller whole life policy for lasting goals.

Is whole life right for you?