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Financial Insights

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Loan Management for Insurance Policies

1 January, 2016

Most whole life insurance policies allow a policyowner to borrow against the contract’s cash value. Much like a home equity loan, this feature maintains the policy’s future value (i.e., the death benefit), while also providing immediate cash resources5. An August 2012 article in the trade publication LifeHealthPro notes how insurance policy loans have played a part in several modern business success stories.

  • During the Great Depression, retailer J. C. Penney borrowed from his life insurance policies to meet the company payroll, and keep his business afloat.
  • When no banker would lend him the money, Walt Disney borrowed from his life insurance in 1953 to help fund Disneyland, his first theme park.
  • In the early 1960s, Ray Kroc, a co-founder and eventual sole owner of McDonald’s, took loans from two cash value life insurance policies during the early years of the business to pay key employees. 
  • With a $3,000 loan from an insurance policy, Doris Christopher started the Pampered Chef, a kitchen tool company, in 1995. Seven years later, she sold the business to Warren Buffett for a reported $900 million. 

For entrepreneurs and business owners, policy loans may be an attractive source of capital for several reasons. Among them:

  • Cash values can be accessed by the owner at any time, for any reason; there is no application or approval process.
  • The terms of repayment are determined by the policyowner. Payments can be scheduled (as a monthly automatic payment), irregular (from a bonus or income tax refund), or even suspended for periods.
  • Skipped or reduced loan payments will not prompt a call from a collection agency or negatively impact your credit score.
  • As long as the policy remains in force, and is not a Modified Endowment Contract, loans are not taxable – even if the amount borrowed exceeds the policy’s cost basis.

Life insurance policy loans can prove a valuable source of liquid funds to meet immediate challenges and opportunities. However, if loans are improperly managed, they can severely impact other policy benefits.

Loan interest is calculated every year at the policy’s anniversary, and if the owner does not make any repayments during the year, the loan balance will increase. With additional interest, it is possible that a loan balance could eventually grow to exceed a policy’s cash value. If it does, the policy will lapse – even if the owner is still paying the regularly scheduled premium.

If you decide to cancel the policy, or if excess loans cause it to lapse, the unpaid loan becomes part of the calculation to determine whether the policyowner has received a taxable gain. Should the insured die with an outstanding loan balance, the loan amount is deducted from the death benefit. (For example: a $10,000 loan against a $500,000 policy would mean beneficiaries would receive a $490,000 benefit if the insured were to die.)

Take care of policy loans, so the policy can take care of you

A whole life insurance policy is a multi-faceted financial instrument that can provide both short- and long-term benefits. But maximizing these benefits requires ongoing review and management. The ease with which policy loans can be initiated, and the liberal terms for repayment, combined with neglect, can result in declining cash values, increasing loan balances, and a policy lapse.