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One way to use the cash value of variable insurance.
Life insurance usually has one objective: provide a financial safety net for your family. That’s all term life insurance does: it’s pure life insurance that provides a death benefit to your beneficiaries if you die.
Permanent policies also offer a death benefit, but in addition, they have a cash-value component that grows the longer you have the policy.
Variable life insurance is a type of permanent life insurance. Its cash value is held in a series of sub-accounts that grow at different rates. Like other permanent policies, it’s possible to take a loan out against that cash value once you’ve had the policy long enough.
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 different from 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.
Read more about life insurance loans.
Taking out a loan against the cash-value component of a variable life insurance policy has three main benefits compared to a traditional loan:
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).
Whether you’re taking a loan against a variable life insurance policy or any other permanent life policy, it’s important to understand your options and repercussions.
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.
Our experts can help you choose the right type of life insurance for your needs.
If you have the cash value built up, taking out a loan with your variable life insurance policy can be an easy and 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.
Once you decide to take the loan, talk to your insurance provider about paperwork and next steps.
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