When can a policy loan make sense?
Life can throw the unexpected at all of us. Before we know it, our children are of college age. Where do you find tuition money? You're unexpectedly unemployed. Where can you easily obtain temporary funds until the next job comes along? In our later years, we may need additional funds to pay for some in-home care as we age. Where do you get the extra money to pay the caregivers?
As an insurance agent, I like the fact that a cash value life insurance policy can be an extra "bucket" of funds if needed for a family. Laypersons and professionals alike have argued for years and years about which is the "better" purchase – term insurance or cash value policies. Read more here about the arguments!
One question that is common is how do loans on life insurance work?
How do I go about getting a loan?
Our sample client, Jack, is 45 years old and purchased a whole life policy. After five years of paying his premiums, Jack decides that his family needs a newer car. He thought about going to the local credit union but decided it would be easier to buy this new car using funds from his life insurance policy that has now accumulated $43,000. Jack needs to borrow $30,000 for that new car. This means that Jack now needs to know how his life insurance loan could work.
A phone call to the life insurance carrier with a loan request will allow the company to issue a check for the requested loan amount. A physical check is delivered to the insured for the amount requested as long as there is sufficient cash value in the policy to allow the loan. The typical amount that can be loaned by the company is approximately 90% of the policy's current cash value.
Interest is charged on that loan to the insured. The current loan rate on a whole life policy that I own is 5.6%. Rates will fluctuate so be sure to call your carrier for details specific to you.
Do I need to pay this loan back? There is no requirement that you pay the loan back. However, if not repaid, the face value of the policy and the cash value account of the policy will decrease and can ultimately lapse the policy. Lapsing the policy means that it is no longer in force with insurance carrier.
A wise way to handle a loan is to structure repayment on the policy loan just as you would a traditional car or home loan. You can use an amortization schedule to determine how long you would like to choose to repay the loan. Add in the current interest rate that you are being charged and you may begin your repayment.
Repaying your policy loan is simple. You can send the insurance company a physical check each month or you can set up automatic payments from your checking account.
What happens if death occurs while a loan is made against my policy?
A common question regarding loans from a life insurance policy is "what happens if Jack died while repaying his loan?". The life insurance carrier would deduct the loan amount still due from the face value of Jack's policy. So, if it were a $200,000 face value and Jack still owed the policy $30,000, the family would receive a check for $170,000 if Jack had passed away.
Use your insurance policy as a financial tool.
Remember that Jack's life insurance cash value account can be used to pay for anything he wants. College tuition. Helping to care for aging parents. Caring for he and his wife when they are 75 and need additional funds. Anything he wants. But, he SHOULD pay the funds back to his policy to keep it in force (which means active).
Managing a policy like this can require a fair degree of discipline. Consult your insurance agent and truly be sure that you understand this purchase. It can be a complex purchase with many nuances that can affect the outcome and performance of your policy. But, skillfully managing this type of policy can lead you to a new bucket of money that flows through your world. I'm an advocate of "many buckets" with a whole life policy being one of them.
This article is a reflection of the author's experience in using a cash value life insurance policy.