When It Makes Sense to Borrow From Your Life Insurance Policy


NEW YORK (MainStreet) — Borrowing from your life insurance policy can be a better bet than taking out a loan from your 401(k) or credit card, experts said.

Since the repayment period for a life insurance policy can be indefinite, consumers can wait until they are drawing a regular paycheck before they start making payments.

Raiding your 401(k) or IRA funds may seem more like financial suicide. While you do not pay penalties or taxes on the income you receive from the loan, all of the loans require you to pay interest. One big drawback is if you are laid off, fired or quit your job, most companies require their employees to pay the entire loan back within 30 or 60 days.

In most cases, you are allowed to borrow only half of your 401(k) balance or up to $50,000, said Ray Caucci, vice president of product management at Penn Mutual Life Insurance Company in Horsham, Penn. The repayment period for the loan varies with each company, but it is generally five years, he said.

Taking out a loan from your life insurance policy is a better option than taking out a personal loan since a credit check or business plan is not required and you can borrow a large amount if needed, Caucci said.

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"There is no fixed term for the loan, you just need to make sure that policy remains in force," he said. "The loan repayments can be made on the policyholder's schedule No additional collateral is required since the policy's cash value is the collateral for the loan."

Another advantage is that interest can be capitalized on the policy loan, meaning there is no requirement to pay interest, Caucci said.

Gallup reported its U.S. Economic Confidence Index was -15 for the week ending May 25, the ninth consecutive week at or near this level. The index is comprised of the average of Americans' views on the current economic situation and their perceptions of whether the economy is getting better or worse.

Gallup found that 20% of Americans rate the current economy as "excellent" or "good," while 34% say it is "poor." Mirroring last week's poll, 40% of Americans feel the economy is getting better, while 55% said it is getting worse. This results in an economic outlook score of -15.

Overall, Americans have said they do not feel the economy is showing "signs of significant upward movement," according to the Gallup poll despite recent statistics showing an increase in job creation and more consumers who said now is a better time to find a good job.

Some insurance policies charge the consumer interest to borrow from it, said Scott O'Brien, director of wealth management for WorthPointe Wealth Management, which has offices in Austin and San Diego.

"I know a lot of insurance salesmen use this as a selling point that you can borrow from your cash value," he said. "What they often fail to mention to the policy holder is that the policy holder will be charged interest on the money they borrow. Some policies do credit the policy owner back some of that interest, but it might not be all of it."

If you fail to pay back the amount borrowed from a life insurance policy, then the amount of the loan is deducted from the death benefit, O'Brien said.

"Having the cash value as a backup source of money to borrow in an emergency would certainly be a positive if you needed the money, but I don't think it's a good reason to buy a cash value policy in the first place," he said.

Tapping into your traditional or Roth IRA is another option if you choose not to use your life insurance policy. The IRS allows you to borrow from either type of IRA without any penalties or fees if you pay it back within 60 days once a year. Raiding a retirement account means employees are not taking advantage of investing their money tax-free or seeing any growth from it. This is basically an interest free loan, but you have to be careful you replace the cash within the 60-day time period. If you miss it by even one day, you are subject to federal income taxes, the 10% penalty if you are under 59 years old and potentially even state income tax.

--Written by Ellen Chang for MainStreet

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