Policy loan
A policy loan is money an insurer advances to the owner of a cash-value life insurance policy, secured by the policy's cash surrender value. Interest accrues on the balance, and unpaid principal and interest reduce the death benefit or surrender value. A large enough balance can cause the policy to lapse.
Also called: loan value
A policy loan lets you borrow from the insurer that issued your permanent life policy, using the policy's cash value as security. Your coverage generally stays in force while the balance stays within the policy's limits, and repayment is usually up to you under the contract. Interest keeps adding to what you owe, and whatever is unpaid comes out of the death benefit or surrender value. If the balance grows larger than the policy can support, the policy can lapse.
How the balance grows and what it takes from the benefit
A policy loan is secured by the cash surrender value or a collateral assignment of the policy, under Conn. Gen. Stat. § 38a-444 (opens in a new tab), and unpaid loans plus interest are subtracted from the death benefit, according to the NAIC (opens in a new tab). The example below uses illustrative policy figures with an 8% rate, the maximum fixed rate payable in arrears described by the New York Department of Financial Services (opens in a new tab).
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| Step | Amount |
|---|---|
| Death benefit | $50,000 |
| Cash value securing the loan | $20,000 |
| Loan taken | $10,000 |
| One year of interest ($10,000 times 8%) | $800 |
| Loan balance after one year | $10,800 |
| Death benefit after the unpaid balance ($50,000 minus $10,800) | $39,200 |
The policy figures are examples, not averages. Your contract may use a different fixed or adjustable rate, may require interest payments, and may credit and charge interest differently. Repaying the $10,000 and the $800 in interest restores the amount your beneficiary would receive.
Loan types, rates and limits that change the cost
These provisions set how much you can borrow and how fast the balance grows.
- Cash loan. You receive money from the insurer, generally up to the policy's cash value and subject to sufficient collateral and the policy terms, according to New York DFS consumer guidance (opens in a new tab).
- Automatic premium loan. If you elected it, the insurer uses cash value to pay an overdue premium after the grace period. That can prevent an unintended lapse, but it adds to the loan balance and the interest.
- Interest rate. New York guidance lists a maximum fixed rate of 7.4% payable in advance or 8% payable in arrears, or an adjustable rate capped at 8% or set by a statutory formula.
- Waiting period. A policy may have a waiting period of up to three years before a loan becomes available, per New York DFS.
A loan is different from a partial withdrawal. A withdrawal takes money out of the cash value instead of creating a balance, and the contract decides whether it lowers the death benefit, the cash value or both. A collateral loan usually means a separate loan from a bank or other lender with the policy assigned as security, which is not the same arrangement.
Where the term shows up
Policy loans belong to permanent cash-value coverage, such as whole life insurance, universal life and variable life. They are not ordinarily part of auto, homeowners, renters, pet, health or business property policies.
The loan provisions sit in the policy contract beside the sections on cash value, interest, lapse, reinstatement and nonforfeiture options. The term also appears on illustrations, annual and in-force statements, loan applications and confirmations, and premium-due or lapse notices. After a death, a claim letter may show an outstanding loan being subtracted from the amount payable. A declarations page may identify the policy without the full loan terms.
How Connecticut and New York shape policy loans
Both states set rules on interest, deferral and notice.
In Connecticut, § 38a-444 (opens in a new tab) includes automatic premium loans in the definition and regulates the interest rate an insurer may charge. Under Conn. Gen. Stat. § 38a-445 (opens in a new tab), a life policy delivered in Connecticut must say the insurer may defer granting a loan, other than a loan to pay premiums, for a stated period of not less than 60 days from the application.
In New York, Insurance Law § 4222 (opens in a new tab) ties loan value to the cash surrender value and lets a policy reserve the right to defer a loan, except a premium loan, for up to six months. If the insurer does not mail or deliver loan funds within ten working days after receiving the required paperwork, Insurance Law § 3227 (opens in a new tab) requires it to pay interest, subject to a $25 minimum and other limits. When outstanding loans plus interest exceed the loan value, the insurer must give at least 30 days' notice before termination, according to New York DFS, so you can repay or pay interest to keep coverage.
Questions to ask an agent or insurer
These questions turn a loan provision into numbers you can plan around.
- What is my current loan value, and how was it calculated? This tells you the most you can borrow and how much cash value secures it.
- What interest rate applies, how is it calculated, and when is it added? Interest grows the balance, and the policy and state law decide whether the rate is fixed or adjustable.
- Does my policy have an automatic premium loan provision, and is it elected? This shows whether a missed premium would create a new loan instead of an immediate lapse.
- What will the death benefit and cash surrender value be if I borrow a set amount and repay nothing for one, five or ten years? The answer shows how principal and compounding interest wear down policy values.
- What notice will I get if the balance threatens a lapse, and what must I pay to keep coverage? Notice rules differ by state and by policy.
Frequently asked questions
These come up before many loan requests.
Can I borrow from a term life policy?
Usually not. Term life insurance generally does not build cash value, and policy loans are tied to cash-value policies such as whole life, universal life and variable life.
Do I have to repay a policy loan?
The contract sets the repayment terms, and repayment is generally optional. Interest is still charged, the unpaid balance is deducted from death or surrender proceeds, and a balance that outgrows the policy value can end coverage. A policy generally lapses when the unpaid balance exceeds the cash surrender value, according to NAIC Statutory Issue Paper No. 49 (opens in a new tab).
Is a policy loan taxable?
A loan may not count as current taxable income while the policy stays in force. A lapse or surrender with an outstanding balance can create taxable income, because surrender proceeds above your investment in the contract are generally taxable, according to IRS Publication 525 (opens in a new tab). The result depends on the policy and your facts.