Whole life insurance provides protection over a lifetime and offers cash value accumulation features, making it possible to access emergency cash at low interest rates through policy loans. But be wary when borrowing against your policy in this manner: Loaning may reduce its death benefit or cause it to lapse altogether.
An interest charge accrues daily on policy loans. If the total loan balance surpasses its cash value and causes policy lapse, additional interest accrues daily and must be paid in order to keep coverage alive.
Many whole life and universal life insurance policies allow their cash value to be borrowed from the insurer without incurring taxes; such loans do not constitute distributions from the policy, but instead utilize funds invested over time.
As with anything, borrowing from life insurance comes with both advantages and drawbacks. One benefit of a policy loan is that it may be easier than applying for conventional bank or credit union loans to qualify – no employment verification or credit check may be needed, and your funds could arrive as quickly as days! In addition, life insurance policy loans often carry lower rates of interest compared to credit card or bank loans.
Borrowing from an insurance policy poses several challenges, with principal and interest owed being returned in full, including any interest charged. If the amount borrowed exceeds its cash value of contract and causes its lapse or surrender with outstanding loans outstanding, any unpaid amount will become taxable as income in the year of withdrawal or surrender.
Whole life insurance is an increasingly popular choice for many people, providing death protection while helping build wealth tax efficiently. But its peculiarities can cause unexpected tax results; borrowing against its cash value may prove costly from an individual tax perspective.
Money you withdraw or borrow from an annuity policy should generally not be treated as income, provided it doesn’t exceed its “policy basis”. A policy’s cost basis refers to premiums paid tax-free. Any amount over this threshold should be reported as income on your tax return.
However, borrowing too heavily against your policy’s cash value may cause it to collapse and require cancellation; in such a situation, taxes on both loan balance and interest could become due.
To avoid this scenario, it is advisable to discuss policy loan terms with your insurance agent or financial professional. They can explain how borrowing against your policy works and help create a repayment strategy in an organized fashion. They can also advise you of the consequences should your policy lapse due to outstanding loan balances.
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Nearly all whole policies provide policyholders with an option to borrow against their accumulated cash value, enabling them to access the cash they’ve built up without having to go through lengthy loan applications and wait for underwriter approval.
Policy loans generally feature lower fixed interest rates than bank personal loans and don’t appear on your credit report as readily. Before making your decision on using policy loans or not, however, it’s essential that you gain an understanding of their workings before taking action.
When loan balances exceed the cash surrender value of permanent policies, their death benefits will be diminished proportionately by any outstanding debts. Furthermore, should a policy lapse or be surrendered before all associated loan funds and interest have been paid back, then the IRS may treat some or all of it as taxable income and recapture it as part of your taxable income.
To prevent this scenario from arising, it’s best to stay on top of loan payments and interest payments to ensure the balance stays under its cash surrender value. An easy way of verifying this information is logging onto your insurer’s website or reaching out to their agent directly.
One major advantage of whole life insurance loans is their non-collateral nature; this makes them especially appealing for those having difficulty qualifying for personal loans from traditional banks. Furthermore, policy loans typically have lower interest rates than credit cards or personal loans.
Before borrowing from your life insurance policy, however, a few key points must be remembered before borrowing money from it. First of all, any loans must be repaid in full; otherwise your death benefit will be diminished accordingly. Furthermore, borrowing against cash value could decrease dividend payments to you which could reduce future death benefits.
Another thing to keep in mind when borrowing against permanent life insurance policies with cash value components, such as whole life and universal life policies. You cannot borrow against term life policies because their cash values don’t build up and thus cannot be borrowed against.
Final tip: Though policy loans may seem convenient in times of emergency, their use should be done so sparingly as over time borrowing from your life insurance will increase debt levels and eventually cause it to lapse.