Knowing the Pros and Cons of Life Insurance Policy Loans
Individuals who borrow money from banks and traditional lenders are required to submit pay stubs, tax returns and financial statements from checking or savings accounts. Life insurance policy loans often simplify the process substantially. In most cases, loan applicants are only required to fill out a single form provided by their life insurance company. The loan is then issued within a few days or weeks. The payment process is often simpler than with traditional borrowing as well. In fact, some insurance companies do not establish a fixed repayments schedule, giving borrowers flexibility when repaying the loan. Life insurance policy loans may also qualify for repayment via policy values instead of cash payments.
Con: Tax Consequences
Life insurance policy loans are subject to tax consequences because the funds are classified as income by the Internal Revenue Service. All proceeds withdrawn from a life insurance policy are subject to state and federal taxes, and therefore, must be claimed on an annual tax return. Of course, the tax rate will vary based on income level, state guidelines and the amount borrowed.
Pro: Lower Interest Rates
Borrowing from a life insurance policy can be cheaper than traditional loans from banks, credit unions and lending institutions. On average, interest rates are lower for life insurance policy loans and borrowers are still accruing dividends and earnings during the loan term. Lower interest rates can save thousands of dollars over the course of a loan term, especially when paid back in a timely manner.
Con: Lowered Assets
The funds withdrawn from a life insurance policy lower the borrower's overall net worth. It may be simpler to borrow from a life insurance policy, but if the funds are not repaid or death occurs before the loan is satisfied, individuals have fewer assets for themselves or their heirs. Borrowers should evaluate the necessity of the immediate funds before borrowing from a life insurance policy so they can ensure their heirs are taken care of with ample death benefits.
People with life insurance policies build assets and cash value that is beneficial for family members after a loved one passes away. A policy loan can also be helpful for individuals in need of a source of cash to pay for major expenses such as home repairs or college tuition. Pros and cons exist for borrowers who dip into their life insurance policies and take out loans that must eventually be repaid. Borrowers should identify the stipulations and costs of borrowing from a life insurance policy before signing on the dotted line.