Understanding the Basics of Life Insurance Policy Loans

A life insurance policy loan can offer policyholders flexible access to accumulated cash value without needing to surrender their policy. This option provides an efficient means of liquidity for emergencies, opportunities, or other financial needs—while keeping the primary death benefit intact.

By law, life insurers must offer the contractual right to take loans against the cash value of certain types of life insurance policies. These loans are collateralized internally by the policy’s death benefit, allowing owners to borrow against their policies at generally favorable interest rates. Typically, a life insurance policy loan is not considered taxable income as long as the policy remains in force until the insured’s death.

There are multiple types of life insurance policy loans available, including fixed and variable rate options. Some policies offer “wash loans,” where the crediting rate matches the loan interest rate, resulting in no net cost to the policyholder under certain conditions. Other policies allow variable loan provisions, where the rate adjusts based on an index or benchmark—creating opportunities for positive arbitrage but also introducing potential risk.

While life insurance policy loans can offer attractive flexibility, they must be used thoughtfully. If a policy lapses with an outstanding loan balance, the borrowed amount that exceeds the policy’s cost basis may be subject to taxation. Therefore, careful monitoring of the loan balance and regular policy reviews are essential to maintaining the integrity of the policy and avoiding unintended tax consequences.

Life insurance policy loans are a powerful tool for accessing liquidity, but like all financial strategies, they work best when implemented with a clear understanding of the risks and benefits involved.

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