Policy Loan
A policy loan is a loan from an insurance company using the cash value of a permanent life insurance policy as collateral, which does not require credit approval and charges interest that accrues if unpaid.
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Exam Tip
Policy loans are NOT taxable when taken. If policy lapses with outstanding loan, there may be tax consequences.
What is a Policy Loan?
A policy loan allows the owner of a permanent life insurance policy to borrow money from the insurance company using the policy's cash value as collateral. Unlike traditional loans, there's no credit check, application process, or required repayment schedule.
Key Features of Policy Loans
| Feature | Description |
|---|---|
| Collateral | Policy cash value secures the loan |
| Credit Check | Not required |
| Repayment | Flexible, no fixed schedule |
| Interest | Charged on outstanding balance |
| Maximum Loan | Up to 90-95% of cash value |
How Policy Loans Work
- Request loan from insurance company
- Borrow up to policy's loan value (usually 90-95% of cash value)
- Interest accrues on loan balance
- Repay at any time, any amount, or never
- Outstanding balance deducted from death benefit if not repaid
Policy Loan Interest
- Interest rate stated in policy (usually 5-8%)
- Interest compounds annually if not paid
- Unpaid interest added to loan balance
- Can cause policy to lapse if loan exceeds cash value
Impact on Death Benefit
| Scenario | Death Benefit Paid |
|---|---|
| No loan | Full death benefit |
| $50,000 loan outstanding | Death benefit minus $50,000 |
| Loan exceeds cash value | Policy lapses |
Tax Implications
| Situation | Tax Treatment |
|---|---|
| Taking loan | Not taxable (it's a loan) |
| Policy in force | No tax on loan |
| Policy lapses with loan | Taxable gain possible |
| Policy surrendered with loan | Loan reduces proceeds |
Policy Loan vs. Withdrawal
| Feature | Loan | Withdrawal |
|---|---|---|
| Reduces cash value | No (temporarily) | Yes (permanently) |
| Requires repayment | No (but advisable) | N/A |
| Interest charges | Yes | No |
| Reduces death benefit | If unpaid | Yes |
Study This Term In
Related Terms
Cash Value
Cash value is the savings component of a permanent life insurance policy that grows tax-deferred and can be accessed through loans or withdrawals during the policyholder's lifetime.
Whole Life Insurance
Whole life insurance is a permanent life insurance policy that provides lifetime coverage with fixed premiums, a guaranteed death benefit, and cash value that grows at a guaranteed rate.
Universal Life Insurance
Universal life insurance is a permanent life insurance policy with flexible premiums and death benefits, plus a cash value component that earns interest based on current market rates.
Death Benefit
A death benefit is the amount of money paid to beneficiaries upon the death of an insured person, typically the face amount of a life insurance policy.
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