Integrity Competence Prudence
Borrowing from a Life Insurance Policy
One of the reasons why some people purchase a cash value life insurance policy be it universal life or whole life is so at some point they have the ability to be able to borrow from the policy. However before borrowing from such policies (yes you are borrowing not withdrawing and yes you have to pay interest ranging around 5%) one needs to be fully aware of some important points.
A policy loan typically involves borrowing up to the cash value you’ve accumulated in the account. If you have a universal life policy, the insurer will move the loan collateral (a cash sum equal to your loan amount) out of your investment fund and into a guaranteed or fixed fund. Since they don’t want to expose that collateral to market downturn. However this could result in negative equity in the policy to where you basically lose your policy. One positive attribute of loans from these policies is that unlike a conventional loan, you don’t have to pay a policy loan back; any money you take out will simply be deducted from your death benefit, which goes to your beneficiaries. But any unpaid interest will be added to your loan amount and will be subject to compounding interest.
The ideal way to deal with loan interest is by paying for it out of your pocket. But if you borrow the maximum amount from your policy and try to pay your loan interest with dividends or by dipping into your policy, you could be headed for serious trouble. That’s because if they fail to cover the full interest due, that unpaid interest will accrue as phantom income where you will receive a 1099 from IRS.
Permanent life insurance policies with a cash value are suitable products for only some people, and buyers need to be fully aware of these products offering, costs and options.