You might have heard about life insurance and the next question that comes to mind is, can you borrow from life insurance? Let’s look at all you need to know about life insurance and if you can borrow from it.
1. What is Life Insurance?
Life insurance is referred to as the financial or monetary agreement usually between an individual and an insurance company. The policy offers protection and peace of mind to the people concerned with the agreement. The person who buys the life insurance policy is often referred to as the policyholder.
They are concerned with regular payments called premiums to the insurance company. The policyholders have the power to choose their beneficiaries. It can either be one family member or more who will enjoy the benefits of the policy when the policyholder is no longer alive. The premium payments are made solely based on some factors which include:
- Health of the policyholder
- Lifestyle of the policyholder
- Age of the policyholder
Bear in mind that a younger and healthier person will pay a lesser amount as a premium.
2. Types of Life Insurance
There are various types of life insurance:
2.1. Term Life Insurance
Term life insurance consists of the following features:
2.1.1. Coverage period
Term life insurance is known to give coverage for a specific period. The specific period is referred to as, a term. The term length can include 10, 20, or even 30 years.
2.1.2. Death Policy
Term life insurance allows the beneficiaries to receive death benefits. These death benefits are gotten only when the policyholder passes away during the term. This is basically the amount that was chosen when the policy was implemented.
For this type of life insurance, the premiums are always lower than the other types. It is the best for a younger and healthier person because it is affordable.
2.1.4. No Cash Value
You should know that with term life insurance, there is no expected accumulated cash value over time. The coverage comes to an end immediately after the term is over. There is also no form of payout when the policyholder is still very much alive.
2.2. Whole Life Insurance
This type of life insurance has the following features:
2.2.1. Lifelong Coverage
In a whole life insurance policy, there is continuance coverage for the insured. This is made possible only if the premiums are paid.
2.2.2. Cash Value Component
A part of the payments made are put in an investment account which is left to gain cash value over time. The cash value can be obtained via withdrawals or loans.
2.2.3. Level Premiums
The premiums in this type of life insurance policy do not change. It doesn’t matter the age or health status of the policyholder, it remains constant.
2.2.4. Higher Premium
They are more expensive when compared with term life insurance. This is because of the lifelong coverage and the cash value component.
2.3. Universal Life Insurance
This is a type of life insurance that gives long-lasting coverage like the whole life insurance policy. However, in this situation, it is more flexible. Universal life insurance allows policyholders to make adjustments to death benefits and premium payments over time. This is done only if there is enough cash value available to fund the policy’s cost.
The cash value is put in an investment company and left to grow at the rate set by the company. This cash can be gotten through taking out loans or making withdrawals. The premium in this policy is not constant as it changes from time to time. However, it is very important that the policy is managed effectively to prevent the depletion of the value of the cash.
2.4. Variable Life Insurance
This type of life insurance merges life insurance with a variety of investment options. Here, the policyholders have the opportunity to assign premium payments into investment accounts like bonds and stocks.
The cash value and survivor benefits of this policy are not static as they change based on the execution of the investments. You should know that this type of life insurance offers higher returns when compared with whole-life and term life insurance. However, it bears the risk of investment losses.
2.5. Variable Universal Life Insurance
This is a type of life insurance that merges the freedom of universal life insurance with the investments component. This gives the policyholders the opportunity to garner control of their death benefits, premium payments, and investment choices.
The variable universal life insurance has the following features:
2.5.1. Cash Value Component
The cash value component in the universal life insurance policy is mainly invested in a wide range of sub-accounts. The growth or decline of the cash value is usually based on the performance of these sub-accounts which are investment funds.
2.5.2. Potential for Higher Returns
Unlike the traditional universal life or whole life insurance policy, variable universal life insurance provides higher returns. This is because the cash value is usually invested in sub-accounts. The cash value grows rapidly if the investments have a good performance.
2.5.3. Risk and Volatility
Since this policy has the prospect for considerable revenue, it also has the prospects for higher risks. Sometimes, the investment sub-accounts become volatile which might lead to losses. It is important that the policyholders monitor and manage their investments as they bear the investment risks.
2.5.4. Fees and Expenses
This type of life insurance comes with a lot of expenses and fees as it is responsible for managing the sub-accounts. You should know that these fees can make a great impact on the growth of the cash value. It is very important to have an in-depth understanding of the fee structure and the ways it can impact the performance of your policy.
2.5.5. Tax Considerations
In this type of life insurance, the policy is tax-deferred. This basically means that you don’t have to pay taxes as the cash value grows till it is time to surrender the policy. This is a good thing as it is of great benefit as it gives tax advantages to policyholders.
2.6. Indexed Universal Life Insurance
This is a type of life insurance that joins the cash value component with the death benefit giving the policyholders the opportunity to gather wealth over time.
Here are the features of indexed universal life insurance:
2.6.1. Permanent Life Insurance
This type of life insurance falls under permanent life insurance because it gives coverage for the lifetime of the insured. This lasts indefinitely especially when the premiums are paid.
2.6.2. Death Benefits
Just like other types of life insurance, the indexed universal life insurance gives out death benefits to the beneficiaries when the insured is no longer alive. The benefit received is usually tax-free which provides financial support to the beneficiaries.
2.6.3. Cash Value Component
In this type of insurance policy, a fragment of the money is paid into a monetary value account and left to grow over time. You’re not expected to pay tax as long as it is within the policy.
2.6.4. Indexed Rate
This basically has to do with how the cash value grows. It is usually connected with a consumer price index. In this case, there is no straightforward investment from the insurance company to the stock market. However, the payments are made based on the interest of the performance of the selected index.
2.6.5. Interest Crediting Methods
You should know that insurance companies give out different types of interest crediting methods. The yearly point-to-point method is the most popular one. This calculates the interest based on the index’s performance.
2.6.6. Downside Protection
This is an advantage of the indexed life insurance policy. The downside protection involves protecting the principal even in cases where the selected index performs poorly. The cash value does not decrease, rather, it remains the same.
2.6.7. Policy Charges
This type of insurance policy usually has some charges and expenses attached to it. These charges include premium loads and insurance administrative fees.
2.7. Final Expense Insurance
This type of insurance can be referred to as funeral insurance. It was created to cover the cost of the burial of the insured or any other related expenses. The objective of the policy is to provide financial relief and support to the loved ones of the deceased.
Final expense insurance has the following features:
The main purpose of this type of insurance policy is to reduce the financial burden that may be a result of the burial expenses. They take care of the cost of transportation, casket, headstone, burial plot, and other expenses. The profit for this policy is relatively small because the coverage is for end-of-life expenses.
Final expense insurance is a type of life insurance that is very easy and straightforward to get when compared to the other types of life insurance. Ranging from the application process and requirements, everything about final expense insurance is swift and stress-free.
Unlike your regular life insurance, the premium payments for final expense insurance are low. This is made affordable because the amounts for coverage are always small. They also created this policy for those with fixed incomes and limited resources.
2.7.4. Guaranteed Issued Option
In this type of insurance policy, individuals are not expected to go through any medical examination. They provide a guarantee-issued option to the applicants. This is of great advantage to people who already have pre-existing health conditions.
2.7.5. Cash Value
This policy helps to garner cash value over time and they can be borrowed to use to cover premiums when necessary. Bear in mind that when you borrow against the cash value, the amount of the survivor benefit will be brought down.
2.7.6. Beneficiary Payouts
Immediately the insured person passes away, the beneficiaries would get the benefits payout. The payment is mostly used for the funeral expenses.
2.7.7. Policy Consideration
It is very important that individuals carefully go over the terms of the policy, coverage, and the like. Concerned individuals should make sure to make inquiries and compare different insurance companies just to be sure that the selected policy meets their budget.
3. Benefits of Life Insurance
The benefits of life insurance include the following:
3.1. Financial Protection
You should know that life insurance policies are there to provide your beneficiaries ( family and loved ones) with the necessary support if you are no longer alive. The payout from the insurance company can be very useful to cater for burial expenses, living expenses, and even outstanding debts.
3.2. Income Replacement
This is one benefit of getting life insurance where the insurance company replaces the income of a primary income earner after death. This is done to enable the affected family to pay their bills, meet financial obligations, and maintain their standard of living.
3.3. Debt Repayment
You should know that you can use life insurance to cover outstanding debts such as personal loans, credit cards, and mortgages. This helps your family not to be a partaker of your financial liabilities.
3.4. Estate Planning
This is beneficial in estate planning in the sense that it helps to cover legal fees or all other expenses that are related to sharing the assets of the insured with the heirs. This also helps to protect the estate value and also makes sure that the transfer of assets is carried out successfully.
3.5. Educational Expenses
Do you know that parents can get life insurance for the sole purpose of funding their children’s education? Now you know. Upon the death of the parents, the payout will be used to cover tuition, books, and other expenses related to the children’s education. The insurance company will help to ensure that the educational goals of the children are met.
3.6. Business Maintenance
If you are a business owner, it is important that you get life insurance. This is because the company will ensure a smooth transfer of the business when the owner passes away. The payouts can help provide financial stability and pay off the business debts.
3.7. Tax Efficiency
You should be aware that the death benefits payout from any of the insurance policies is usually tax-free. The growth of the monetary worth in permanent life insurance is done on a tax-deferred basis.
You can decide to use a charity organization as your beneficiary thereby making a charitable impact.
3.9. Flexible Options
There are different forms of life insurance like, whole life insurance, universal life, term life, and variable life insurance. This gives you the opportunity to select the policy that aligns with your financial commitments.
4. Can You Borrow from Life Insurance?
It is important to note that you can actually collect loans from life insurance. Most of the insurance policies offer cash value which piles up over time as long as the money is paid. This is how it works:
4.1. Growth of Cash Value
Cash value grows as premium payments are made especially in the permanent life insurance policy. A part of the payment is usually used to build cash value. The growth of the monetary value is usually on a tax-deferred basis.
You can choose to borrow against the monetary value policy when in dire need. This borrowing process is known as policy loans. One great thing is that the loan is given at a subsidized interest. You are also not expected to go through the stress of a credit check because you are literally borrowing money from yourself.
The funds borrowed can be used for different purposes like paying off unexpected expenses, funding education, and paying off debts.
It is not mandatory to repay the loan instantly. However, the outstanding loan will garner interest over time. In a situation where you fail to repay the loan while still alive, the amount of the loan and the interest will be removed from the death benefits.
4.5. Potential Risk
It is advisable to be very careful when thinking of borrowing for your insurance policy. Bear in mind that if the repayment of the loan is not done, it reduces the monetary value and survivor benefit of the policy. In a case where the outstanding loan is way too much, it can lead to policy lapsing. This automatically means termination of the coverage.
Before you make the attempt to borrow from a life insurance policy, it is important that you consult your financial advisor so that you can get a thorough understanding of the terms and potential risks. Your financial advisor is there to assist you in making decisions based on your financial capabilities.
5. Disadvantages of a Life Insurance Loan
Borrowing from a life insurance policy also comes with some disadvantages:
5.1. Reduced Death Benefits
Money borrowed against cash value is removed from the death benefit of the policyholder. This implies that a reduced death benefit will be given to the beneficiaries of the individual who doesn’t repay the loan before passing away.
5.2. Interest Charges
Loans borrowed from insurance policies insure interest over time. Although the interest might be low when compared to several forms of borrowing, it doesn’t rule out the fact that the interest can accumulate, thereby reducing the overall loan balance.
5.3. Impact on Cash Value
Taking out loans from cash value can decrease the amount of money earned as interest. This can also reduce the growth of the monetary value of the policy.
5.4. Repayment Pressure
There is always this pressure to repay policy loans because of the fear of its impact on your death benefits or policy performance. This could lead to financial constraints.
5.5. Opportunity Costs
Keep in mind that the loan taken from your policy’s cash value will not be able to earn returns anymore. This depends largely on the potential investment and performance of the policy.
5.6. Risk of Lapses
If you are faced with a situation where the balance of the outstanding loan is too high, it can lead to policy relapse.
5.7. Compounding Interest
When an interest is not paid, it is automatically added to the loan balance. This can lead to remarkable growth of the loan amount. It can be very difficult to repay which will result in a reduced death benefit.
5.8. Policy Dependency
When you fully rely on a policy loan for your financial needs, it can lead to a situation where your financial stability is linked to the performance of your insurance policy. In a case where there is an economic downturn or an underperformance of the policy, your ability to pay back the loan can be affected.
6. Final Thoughts
It is very important that you have an in-depth understanding of the terms, potential risks, and implications before taking out any policy loan. A financial advisor can lead you through this process.