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Borrowing and the Whole Life Policy

By Lucas Siegel

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What You Need to Know

  • One option is a loan from the issuer.
  • A second option is a loan from a bank.
  • A third option is a broker-funded loan.

People generally purchase whole life insurance for the death benefit and the cash that accumulates in the policy. Unfortunately, accessing that cash can be more complicated than policyholders expect.

A common approach is to use the policy’s cash value as collateral against a loan. Borrowing to unlock value from life insurance is appropriate when your client wants to retain part of the death benefit for the beneficiaries. Any other options for liquidating life insurance — surrendering or selling the policy, for example — leave no death benefit for the policyholder’s loved ones.

Many policyholders know they can borrow directly from their insurance carrier. But there are also two other options. Your client can use the whole life policy as collateral for a bank loan. Or your client can obtain a loan through a third-party broker. Read on for a closer look at each of these options, so you can guide your clients to the solution that suits them best.

1. Borrowing Directly from the Insurance Carrier

An insurer-funded loan uses the policy’s cash value as collateral. Repayments are technically not required — but not paying at least the interest can put the policy at risk. Unpaid interest is added to the loan balance, which in turn accrues more interest.

Eventually, the interest expense can exceed the policy’s dividend income. When that happens, the policyholder will have to pay in more to protect the policy’s solvency.

At the same time, the policyholder must stay current on premiums. If the policy lapses for any reason, the policyholder will receive a 1099 for the difference between the loan balance and the cumulative premiums paid. By IRS standards, that amount is income, taxable at the policyholder’s ordinary income rate.

If the loan is not repaid when the policyholder dies, the insurer collects the outstanding balance plus accrued interest from the death benefit.

Insurer-funded loans are best for policyholders who are 100% committed to making future premium payments and repaying their loan. Staying current on premiums avoids nasty tax consequences. And repaying the loan balance keeps the death benefit intact.

One challenge policyholders will face is prioritizing loan repayment when the insurer doesn’t require it. Policyholders may initially intend to repay the loan, only to change their minds later. That can be problematic if it puts the policy at risk.

2. Borrowing From a Bank

Policyholders may also use their whole life policy as collateral for a bank loan or line of credit. The policyholder will have to complete a loan application — which an insurer wouldn’t require. But the bank’s interest rate is usually lower than what an insurer would charge.

As part of the loan terms, the policyholder must agree to pay future policy premiums. Not doing so puts the loan in default.

If the loan is still outstanding when the policyholder passes, the bank repays itself from the death benefit. Any remaining amount is paid out to designated beneficiaries.

These bank loans can be structured with interest-only or principal-and-interest repayments. As with an insurer-funded loan, the policyholder in this scenario will have ongoing premium payments — plus loan repayments. If the loan has a variable interest rate, that repayment burden could rise over time.

3. Borrowing From a Third-Party Broker

Broker-funded loans also take the whole life policy as collateral. However, the broker/lender will assume responsibility for the policy’s premiums going forward. So, the broker-funded loan results in a cash payment to the policyholder — up to 95% of the policy’s cash value — and eliminates the burden of future premiums.

Repayment of interest and/or principal is optional, and the broker guarantees a minimum death benefit. If the policyholder makes no repayments, the interest accrues until the policyholder passes. The broker then repays the loan plus interest from the death benefit. Beneficiaries would receive any amounts remaining or the minimum guaranteed death benefit.

Unlike the insurer-funded loan, a third-party broker loan has no potential tax consequences. There’s no danger of a policy lapse since the broker keeps the policy in force.

Relative to a bank loan, the third-party broker loan lowers the policyholder’s future out-of-pocket expenses — since premium payments and loan repayments are not required.

The policyholder does have the option of repaying a third-party broker loan. Doing so would restore the full death benefit and shift the responsibility for premiums back to the policyholder.

Broker-Funded Loan Example

Consider a $250,000 whole life policy with a cash-value balance of $100,000. This policy could support a broker-funded loan of up to $95,000.

If the policyholder passes away just after the loan funds, beneficiaries will receive a death benefit of $155,000, or the $250,000 policy value less the $95,000 loan balance.

As time passes, if no repayments are made, that death benefit would be reduced by accrued interest and future premium payments. The death benefit cannot, however, fall below the guaranteed minimum.

Because the broker pays the premiums going forward, a broker-funded loan is useful for policyholders who need to lower their expenses. It’s also a good option when the policyholder wants to keep some of the death benefit but does not plan on repaying the loan.

A More Flexible Option

All three types of whole life insurance loans can produce fast cash with optional repayment. But the broker-funded loan is the most flexible solution for the policyholder. The policyholder raises cash while eliminating premium payments — without the worry of lapsing the policy and accidentally incurring taxes.

The outcomes for your clients are cash now, elimination of out-of-pocket premium and interest expenses, and a guaranteed death benefit. That’s a tough combination to beat.

Lucas SiegelLucas Siegel is the founder and chief executive officer of Harbor Life Settlements, a life settlement company, and Harbor Life Brokerage, a life settlement broker.

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