If you find yourself in a difficult financial position, you may be considering borrowing money from a life insurance policy or annuity. This is a viable option for many people that can help solve a financial crisis, but you should be aware of exactly how it works and what repercussions it may have before you proceed.
About Borrowing Money from a Life Insurance Policy or Annuity
Many people jump to the conclusion that life insurance policies, which usually are taken out for a value well into the thousands of dollars, have an extensive amount available for you to borrow from should you need it. This assumption isn't always accurate; in fact, depending on the rules of your particular policy, the amount you can borrow as well as when you can borrow it may be quite limited. It's important to understand precisely how much money might be available for you to borrow from your policy or annuity before you consider beginning the process.
How Much Can You Borrow?
In order to calculate what's available to you, you must understand the difference between face amount and cash value. Your policy will have a set face amount, which is the amount that would be paid to your beneficiaries upon your death. This is the "amount of coverage" that you purchased in the first place. The cash value, on the other hand, is the actual amount that you pay into the policy over the years that you have it. Your premiums accumulate and collect interest over time and this total amount is what constitutes your cash value. The amount that you pay into your account is tax-free and, as long as you leave it in the policy without withdrawing it, it will remain so.
If you're borrowing money from a life insurance policy or annuity, you are allowed to borrow from the cash value amount. If you have a $10,000 policy but you have only paid $5,000 into it, you may only borrow $5,000 (and often you can only borrow a percentage of the cash value, such as 75 percent). Some policies will not allow you to borrow from them until they have been in existence for a set amount of time, typically around three years.
You should also keep in mind that some insurance policies will let you borrow against your own policy interest-free, but others do charge interest on the loan. Typically it's a fairly small amount, which can be a benefit for those who need money but only have the option of high-interest loans from other sources.
The act of borrowing itself is fairly simple; customer service at your insurance company can walk you through it and after the paperwork is completed, you'll receive a check in the mail for the balance borrowed. In some cases, borrowing money from a life insurance policy or annuity can be an interest-free loan. This will depend on the regulations of your particular policy
Keep in mind that there can be tax repercussions associated with borrowing money from a life insurance policy or borrowing from an annuity. The dollars you pay into your account are tax-free, but upon having removed them, they are no longer tax-free and the loan must be calculated and reported on your income tax for the year.
Repayment on these loans is typically fairly flexible; the point is to repay it, but the insurance company and the rules of your policy may or may not be very specific on when or how that needs to be done. This can be to your advantage provided you are disciplined enough to pay it back without a set deadline.
If you're considering borrowing from your policy, you should consider all other borrowing options available to you. If it's within your ability to get a low-interest personal loan from a bank or credit union, that's a better option than borrowing against your policy. On the other hand, if all that is available to you from other lenders are high interest loans or credit cards, then borrowing from your policy may be an efficient and frugal way to get the money you need. Just make sure that you do it only when you really need it, and that you pay it back as promptly as possible.