Have you heard about life insurance policy loans and wondering what they are and how they work? A policy loan is a collateralized loan against the equity or cash surrender value in your life insurance policy. And this is a key distinction, because several times I’ve spoken to people who were misinformed, on exactly what a policy loan is.
They were told that a loan against your policy is a loan against the death benefit, that is technically not correct.
Although policy loans will decrease your death benefit dollar for dollar if you’re to die with a policy loan balance, it’s technically collateralized against the policy cash value. And this is a big difference because you don’t have access to that full death benefit while you’re alive, but you do have access to the amount of cash value that has collateralized and built up in your policy throughout your policy years.
Now, it doesn’t matter which insurance company you’re working with as long as you have a cash value building life insurance policy like a whole life universal or variable universal life policy, you have access to the policy loans via the policy loan provision included in those contracts.
So the next issue with policy loans is when or how soon can you take a loan or borrow against the equity of your policy? And the answer is it depends. It depends on the company. Some companies allow for loans after ten days or within the first 30 days. Other companies discourage policy loans in the first year.
It’s important to address these questions before placing your policy in force, because the last thing you want to do is plan on using that policy value during the first year and not have access to it to accomplish your short term goals.
The next question is how much cash are you able to get your hands on and that again, depends on the policy. If you have a policy designed for cash accumulation, typically it has some type of rider and the rider allows you to build up that cash value quicker so you have access to it sooner.
You can expect about 85 to 95% of the contribution that’s going towards the rider to be accessible immediately. However, if you have a regular or whole life insurance policy or other permanent life insurance policy, there’s likely some cash value in it, especially if you’ve had it for several years. And typically you could get your hands on about 90% of that cash value via the policy loan.
So you’ve decided that you’re ready to take a policy loan. How do you go about accessing that money? Well, it’s real simple. You’re giving an order to the insurance company with either a form, a phone call or going online and requesting that policy loan. They’ll either send you a check or put the money right into your bank account.
But then the next question becomes, how do you pay that loan back? And do you have to? You see, life insurance policy loans are unstructured loans, which means there’s no coupon booklet or payment schedule that goes along with the loan. It’s completely up to you as to when or whether you pay the loan back.
And the reason is the entity, the insurance company that is making the loan is also the entity that is guaranteeing the collateral, the equity in your policy. The insurance company is literally verifying to themselves whether or not you have equity in your policy. As the equity appears or when you have equity, the insurance company can release that money to you through the loan provision. Since it is a loan, a separate loan from the insurance company against your cash value, the policy loan will accrue interest.
And what that means is basically on your policy anniversary, the insurance company will send you a bill for interest if you have a loan outstanding. It’s typically anywhere between 4 and 6%, maybe a little more, maybe a little less, and it can fluctuate.
But every year you’ll get that policy loan interest bill and you have the option to pay it. And as long as there’s enough cash value within the policy, you don’t have to pay it and it will accrue onto your loan balance. But we do recommend that you at least repay the loan interest so your loan balance doesn’t continue to grow year after year.
And this is important, you understand, because the loans are unstructured, the decision to pay back the interest or to pay back the principal is completely yours. The interest is charged, but the decision to pay it is yours. And that’s why we utilize policy loans to help our clients regain control of their money.
Now, you may be wondering why would you want to pay that policy loan back? And the answer again is control. As soon as you pay that policy loan back, you’re releasing equity within that policy. So you’re able to access that money again in the future.
This is very different than when you’re repaying your loan to, let’s say, a credit card or other loan, because once you give that payment to that other entity, you no longer have any access or control or you’re giving up opportunity costs on each one of those dollars.
You see with policy loans if you take a policy loan, this becomes your loan balance. Your equity is reduced dollar for dollar by the loan balance. Every payment you make on the loan reduces the outstanding loan balance and increases your equity. And that’s the key. Now you control that money because you’re the owner of the policy. You could ask for another loan, and another loan, and another loan, as long as there’s equity you can borrow.
Now, at this point, you may be wondering, what do people use policy loans for? And there’s a variety of reasons. We have people who are buying real estate, investing in their business, doing other investments in the marketplace, earn an external rate of return as well as their internal rate of return within the policy.
We have other people who are trying to get out of debt and they’re building their savings in the policy and also getting out of debt simultaneously. And what this allows to happen is they’re able to get out of debt often faster and still build their savings within the policy so they don’t have to put themselves in that situation going forward.
Another reason why people would borrow against their life insurance cash value is to create a volatility buffer against their retirement portfolio. We’ve done a previous video that explains how a volatility buffer works, but real simply, instead of taking money out of your retirement portfolio in the year that the market is down, you would forgo taking money out of that account, borrow money against your life insurance to supplement your income and give your portfolio an opportunity to regenerate or regrow itself.
Another great use of policy loans could be sending your children to college and funding the tuition through the policy loans. Did you know that accessing money from your life insurance policy and building that equity within your policy is completely off the FAFSA calculation in most cases?
Another reason why people would take a policy loan would be to buy a car or to remodel their home. And finally, for a medical or financial emergency, you see the key in life is having access to capital. And one of the things about life insurance, cash values is that money is liquid and you can use it and you control it. We call it liquidity use and control or “the luck factor.”
If you’re ready to get started with a whole life insurance policy designed for cash accumulation or could use some more guidance on using your existing life insurance policy, be sure to visit our website at Tier1Capital.com.
Feel free to schedule your free strategy session or if you’d like to learn more about how our process works, check out our free webinar, Four Steps to Financial Freedom.
And remember, it’s not how much money you make, it’s how much money you keep that really matters.