Life Insurance Policy Loans and Withdrawals – How and When to Use Them

Can I Borrow From My Life Insurance Policy?

With permanent life insurance, you have options to access the surrender value (commonly called cash value) that builds in your policy. You can withdraw funds directly, take a policy loan, or use your cash value as collateral to borrow from the insurance company.

57-page slide deck

Many people are losing money with typical financial planning. Even people who were "set for life" are running out of money in retirement. Here's an easy guide with 3 things you can do to become wealthier. Download here>

Each option affects your policy differently, so understanding the implications is crucial for making good financial decisions.

Policy Withdrawals vs Policy Loans

A withdrawal permanently reduces both your cash values and death benefit. With universal life insurance, this reduction could force you to pay more premiums out-of-pocket or even cause your policy to lapse. For whole life insurance, withdrawals reduce your coverage amount and future dividend potential.

Universal life insurance loans:

• Reduce your available cash value by the loan amount
• Require interest payments at a predetermined rate
• Convert to a withdrawal if not repaid

Whole life insurance loans:

Whole life insurance loans work differently – they don’t reduce your cash values since they’re used as collateral. This means your policy continues earning guaranteed growth and potential dividends while the insurance company lends you money from their general fund.

Tax Implications of Policy Withdrawals

Be aware that withdrawals exceeding your cost basis (total premiums paid) trigger taxable income. This unnecessary tax burden can often be avoided by taking a policy loan instead. Many policy owners don’t realize this and end up with avoidable tax consequences.

Understanding the Infinite Banking Concept and How It Works In Our Modern Environment 31-page eBook from McFie Insurance Order here>

Schedule Appointment »

Understanding Loan Mechanics

Universal Life Insurance policy loans give you two options:

1. Borrow directly from your accumulated cash value
2. Use your cash value as collateral for a company loan

With option one, you repay yourself with interest according to your contract. With option two, you pay the insurance company interest on their loan to you. Either way, your continued policy growth depends on your specific contract terms.

Whole life insurance policy loans are more straightforward – you never actually borrow your own money. Instead, your paid-up insurance serves as collateral for a loan from the insurance company. This preserves your guaranteed growth rate and dividend potential (though dividends may be affected differently by direct vs non-direct recognition companies).

Taking a Policy Loan

The process is simple – just submit a loan request form to the insurance company. They’ll transfer funds to your bank account or mail a check.

For whole life insurance, your policy continues growing according to the guaranteed contract while securing the loan. With universal life, you’ll need to specify whether you’re borrowing your own money or using it as collateral.

While getting a loan is straightforward, you must carefully evaluate whether it makes financial sense.

When to Take a Policy Loan

A policy loan makes sense when you can either make more money or keep more money than without the loan. Let’s look at some examples:

If you have $10,000 in credit card debt at 12% interest and can get a 5% policy loan, you’ll save 7% – a clear win. But what if your existing debt is at 3% and the policy loan is 5%? You need to consider:

• Expected policy growth during the loan period
• Your loan repayment timeline
• Potential cash flow improvements

Let’s analyze a scenario with a $10,000 cash value growing at 2.75% annually:

Over 5 years:

• Paying 3% on original debt costs $10,917.73
• A 5% policy loan costs $11,548.74 in interest BUT
• Your policy earns $1,452.73 in guaranteed growth
• Net cost difference is only $96.01
• Without the policy, you lose $2,369.46 in combined growth and interest

The policy loan lets you keep about 55.35% more money overall. This demonstrates why calculating the total financial impact is critical.

6 Good Reasons for Policy Loans:

1. When you can earn more than the loan interest
2. To transfer and reduce debt costs
3. To improve monthly cash flow with flexible repayment
4. When you need quick capital access
5. To protect retirement accounts in market downturns
6. To increase retirement income

5 Bad Reasons for Policy Loans:

1. When you can’t earn more than the loan cost
2. Without intending to repay
3. To fund another policy indefinitely
4. For speculation rather than sound investments
5. For ongoing living expenses (unless retired)

Frequently Asked Questions

Which life insurance company is best?

This depends entirely on your specific situation. Life insurance costs vary based on age, gender, lifestyle and policy details. Work with a knowledgeable agent to find the right fit.

What does life insurance cost?

Premiums depend on individual factors like age and health. Consult a licensed agent for accurate quotes based on your situation.

Policy Checklist Make Sure You Get a Good Policy Is your policy good or bad? Use this checklist to help evaluate your existing life insurance or a new policy you are considering. Get It Here>

When can I borrow against my policy?

This varies by policy type and cash value accumulation. Building sufficient cash value typically takes several years, often a decade or more.

How much can I borrow?

Most companies allow loans up to 90% of cash value, though some permit 100%. Check your specific policy details and consult your agent.

Conclusion

Policy loans can be valuable tools for managing money and building sustainable wealth when used appropriately. They’re not magic solutions as some agents claim when promoting concepts like Infinite Banking or Bank On Yourself. However, when the math works in your favor, policy loans offer a way to maintain control of your money instead of paying others to manage it.

The key is understanding that policy loans are simply tools – neither magical nor dangerous when used wisely. Focus on the actual numbers and only use policy loans when they truly help you keep more of what you make.

Tomas P. McFie DC PhD

Most Americans depend on Social Security for retirement income. Even when people think they’re saving money, taxes, fees, investment losses and market volatility take most of their money away. Tom McFie is the founder of McFie Insurance which helps people keep more of the money they make, so they can have financial peace of mind. His latest book, A Biblical Guide to Personal Finance, can be purchased here.