Borrowing From a Life Insurance Policy: How It Works, Costs, and Risks

If you own a permanent life insurance policy with cash value, you can usually borrow against it. There’s no credit check, no loan application in the usual sense, and no fixed repayment schedule. That flexibility makes policy loans one of the most useful features of whole life and universal life insurance.

But a policy loan isn’t free money. Interest builds, unpaid loans shrink the death benefit, and a loan that grows too large can cause the policy to lapse and trigger a tax bill. This guide explains how borrowing from a life insurance policy works, what it costs, and how to use it wisely.

How does borrowing from life insurance work?

When you take a policy loan, you aren’t withdrawing your own cash value. You’re borrowing money from the insurance company, and your cash value serves as collateral. The cash value stays in the policy, and depending on the policy, it may continue to earn interest or dividends.

Because the insurer already holds the collateral, there’s no underwriting for the loan. You request the money, the insurer sends it, and the loan balance is tracked against your policy. You can repay all of it, part of it, or none of it during your lifetime. Anything unpaid when you die is subtracted from the death benefit your beneficiaries receive.

Which policies let you borrow?

Learn more about the policies that build cash value in permanent life insurance.

How much can you borrow?

Most insurers let you borrow up to a large share of your policy’s cash surrender value, often close to the full amount minus enough to cover interest and charges for the coming year. The exact limit is in your policy. Early in a policy’s life, cash value is small and surrender charges may apply, so there may be little available to borrow. Check your annual statement or call your insurer for your current loan value. For the difference between cash value and what you can actually access, see cash value vs. surrender value.

Policy loan interest rates

Your policy contract sets how loan interest works. There are two common approaches:

• Fixed rate. A set rate stated in the policy that doesn’t change.
• Variable rate. A rate that can adjust, often annually, based on a benchmark named in the policy, subject to state rules.

Interest usually accrues annually. If you don’t pay it, it’s added to the loan balance and starts accruing interest itself. Over many years, unpaid interest can grow a small loan into a large one.

Some policies reduce the net cost of borrowing. With certain whole life policies, borrowed cash value continues to earn dividends. With some indexed universal life policies, an indexed loan lets the borrowed amount keep earning index credits. These features can lower your effective cost, but they can also work against you if dividends or credits come in below the loan rate.

Example: how a policy loan grows

Here’s a hypothetical example. Sam borrows $20,000 from his whole life policy at a 6% loan rate and doesn’t make any payments:

If Sam dies with that balance unpaid, his beneficiaries receive the death benefit minus the loan. If the loan grows larger than his cash value while he’s alive, the policy can lapse.

Is a life insurance loan taxable?

Generally, no, as long as the policy stays in force and isn’t a modified endowment contract (MEC). Policy loans aren’t treated as income because you’re borrowing against the policy, not withdrawing from it.

Two situations can change that:

• The policy lapses or is surrendered with a loan outstanding. The loan balance is treated as money you received. If the total exceeds your cost basis, usually the premiums you paid, the difference is generally taxable as ordinary income, as described in IRS Publication 525. This can happen even though you receive no cash at the time.
• The policy is a MEC. A policy funded too heavily in its early years can become a modified endowment contract under federal tax rules. Loans from a MEC are taxed as income to the extent of gain, and may face an additional 10% penalty if you’re under 59½.

Ask your insurer whether your policy is a MEC before borrowing, and talk with a tax professional about any large loan.

Pros of borrowing from life insurance

• No credit check or approval process. Your cash value is the collateral.
• Flexible repayment. No required monthly payments.
• Fast access. Many insurers send funds within days.
• Generally tax-free while the policy stays in force and isn’t a MEC.
• Use it for anything. Emergencies, a business opportunity, college costs, or retirement income.

Cons and risks

• Interest builds. Unpaid interest compounds and grows the balance.
• Smaller death benefit. Your beneficiaries receive less if the loan isn’t repaid.
• Lapse risk. If the loan and interest exceed the cash value, the policy can end.
• Possible tax bill. A lapse with a loan outstanding can create taxable income.
• Slower cash value growth. Depending on the policy, borrowed cash value may earn less.

Policy loan vs. other ways to borrow

Policy loan vs. withdrawal

Many universal life policies also allow partial withdrawals. A withdrawal permanently removes money from the policy and usually reduces the death benefit dollar for dollar. Withdrawals are generally tax-free up to your cost basis. A loan, by contrast, can be repaid to restore your full benefit. If you’ll need the money only temporarily, a loan is often the better fit. If you won’t repay it, a withdrawal up to basis may avoid loan interest. Compare both with your insurer before deciding.

How to borrow from your life insurance policy

1. Check your loan value. Find the maximum loan amount on your annual statement, online portal, or by calling the insurer.

2. Ask the key questions. What’s the loan interest rate, and is it fixed or variable? Will borrowed cash value still earn dividends or credits? Is the policy a MEC?

3. Request an in-force illustration. Ask the insurer to show how the loan will affect cash value and the death benefit over time, including whether the policy could lapse.

4. Submit the request. Most insurers accept loan requests online, by phone, or with a short form.

5. Make a repayment plan. Even small regular payments, or paying the annual interest, can keep the balance from growing out of control.

When borrowing from life insurance makes sense

• You need short-term cash and plan to repay it.
• You want to avoid a credit check or high-interest debt.
• You’re using the policy as part of a retirement income plan and monitor it closely.
• You have a business opportunity or emergency, and other options cost more.

When to think twice

• Your family still depends on the full death benefit.
• Your cash value is small compared with the amount you want to borrow.
• You don’t expect to repay, and interest could push the policy toward lapse.
• Your policy may be a MEC.

The NAIC encourages policyowners to review loan provisions and ask their insurer how a loan affects the policy before borrowing.

Using policy loans for retirement income

Some people use policy loans as a source of supplemental retirement income, especially with well-funded whole life or indexed universal life policies. The idea is to borrow a set amount each year, tax-free while the policy stays in force, and let the death benefit repay the loans at death.

This strategy can work, but it requires careful management. The loan balance grows every year from new borrowing and interest. If cash value growth falls short, the policy can approach lapse late in life, when replacing coverage is impossible and a lapse could create a large tax bill. If you plan to use your policy this way:

• Ask for an in-force illustration showing the loan plan under conservative assumptions.
• Review the policy every year and reduce or stop borrowing if the margin narrows.
• Ask whether your policy has an overloan protection rider, which can help prevent a lapse when loans become very large.
• Coordinate with a tax professional and a financial planner.

Common reasons people borrow from life insurance

• Emergency expenses such as a medical bill or home repair, without using a credit card.
• Paying premiums during a tight year to keep the policy in force.
• Business needs like covering a cash-flow gap or funding equipment.
• Education costs for a child or grandchild.
• Paying off high-interest debt when the policy loan rate is lower.

Whatever the reason, borrowing works best when you have a clear plan to repay, or at least pay the annual interest, so the loan doesn’t quietly erode your family’s protection.

The bottom line

Borrowing from a life insurance policy can be a fast, flexible, and tax-efficient way to access cash, with no credit check and no required payments. The trade-off is that every unpaid dollar, plus interest, comes out of your family’s death benefit, and a loan left unchecked can end the policy entirely. Know your loan rate, watch your balance, and have a plan to repay. If you’re not sure how a loan would affect your coverage, ask your insurer for an illustration or talk with a licensed agent first.

Borrowing from life insurance FAQs

Can you borrow from a life insurance policy?

Yes, if it’s a permanent policy with cash value, such as whole life or universal life. Term life insurance has no cash value to borrow against.

Do you have to pay back a life insurance loan?

No. Repayment is flexible. But any unpaid loan and interest is subtracted from the death benefit, and a growing balance can cause the policy to lapse.

How much can I borrow from my life insurance?

Usually up to most of your cash surrender value, as set by your policy. Check your statement or ask your insurer for your current loan value.

Is a life insurance loan taxable?

Generally no, while the policy stays in force and isn’t a modified endowment contract. If the policy lapses with a loan outstanding, part of the loan may become taxable.

How fast can I get a loan from my life insurance?

Many insurers process loan requests within a few days to a couple of weeks.

What happens if I die with a policy loan?

The insurer subtracts the unpaid loan and interest from the death benefit and pays the rest to your beneficiaries.