Life insurance usually has one objective: provide a financial
safety net for your family. That’s all term life insurance does. But if you’re looking for a more diverse financial instrument — and have time for complexities — permanent life insurance is an option. Permanent life insurance — including variable life insurance — allows you to take a loan against the policy, giving you a cash influx to use as needed.
What is variable life insurance?
It’s worth talking to a licensed expert or reading our full explainer on variable life insurance if that’s the type of policy you’re considering, but here are the basics.
Variable life insurance, like all forms of permanent life insurance, has a death benefit (that gets paid to your beneficiaries if you die) and a cash value component. The cash value grows or shrinks over the life of the policy. Different permanent policies have different ways of handling the cash value investment. Variable life insurance uses sub-accounts that are similar to mutual funds.
The cash value is key when talking about variable life insurance loans. You’re borrowing against the cash value that’s built up in your policy. That makes it unique to term life insurance, which doesn’t have a cash component and consists solely of a death benefit. You can do a lot of different things with the cash value of a permanent policy. Taking out a loan is one of the most popular options.
The pros of a variable life insurance loan
Taking out a loan against the cash value component of a variable life issuance policy has three main benefits compared to a traditional loan:
- You can get the loan faster
- You can get the loan tax-free
- You can (usually) get the loan at a lower interest rate
How much can you borrow from your life insurance policy? It depends on the cash value amount. Loans are usually available for up to 90% of the cash component. There are fewer credit qualifications, so you won’t get turned away like you might for a traditional loan. Plus, you technically don’t have to pay the loan back, although there are consequences for that (which we’ll get into below).
The cons of a variable life insurance loan
Whether you’re taking a loan against a variable life insurance policy or any other permanent life policy, you should think twice about doing so.
First, a life insurance loan has its limits. You can wait years before you have enough of cash value built up to even take one out, so it's not guaranteed financing to plan on from Day One.
Second, the loan is tax-free, but taxes can accrue on the interest that builds up if you use policy dividends to pay it off. You might be expecting an easy low-interest loan and end up with a huge tax bill because you haven’t focused on paying the loan back.
Finally — and most importantly — the loan affects the death benefit. If you die while the loan is out, the balance is taken from the benefit before it reaches your beneficiaries. The main purpose of life insurance is to provide a tax-free lump sum of money to your loved ones, and you’re putting that at risk when you take out a loan.
Talk to an expert
Having said all that, taking out a loan with your variable life insurance policy is easy and it’s a smart financial move under the right circumstances. Plus, you pay more for a permanent life insurance policy compared to a term policy, so you might as well use the extra perks when needed.
But before you do so, talk to a licensed insurance expert or financial adviser. A life insurance loan has unique strengths, but also unique risks. Know what you’re getting into before deciding if this potentially useful tool is right for you.