Can You Borrow Against a Universal Life Insurance Policy?

Universal life insurance has a lot of unique advantages over a traditional term policy. In addition to providing lifelong coverage, policyholders have the flexibility to adjust their death benefits as needed so that the policy premiums remain affordable.

Like other types of permanent-style life insurance, a universal life insurance policy also has a cash value component. Cash value is like a savings account within the policy that you can use for many purposes.

If you have or are thinking about getting one of these types of policies, then you may be wondering: Can I borrow against my universal life insurance? Here’s everything you need to know.

Is borrowing against universal life allowed?

Yes, it is possible to borrow against a universal life insurance policy. Before you can do this, the policy needs to have built up a minimal amount of value (the exact number will vary per provider). This implies that you’ve likely had the policy for several years and have made several contributions to it already.

Additionally, the policy must also be in good standing. This means that the premiums paid are up-to-date, and no other outstanding loan amounts or claims are against it.

What can cash value be used for?

The cash value component of a life insurance policy can be extremely lucrative. Borrowing against the cash value essentially turns your life insurance policy into a private bank where no credit checks or underwriting are required.

Financial experts often recommend utilizing the cash value from a permanent life insurance policy for all kinds of strategic financial actions, such as:

• Paying off high-interest debt
• Investing in an income-producing asset (like a rental property)
• Seed capital to start a new business

What’s even better is that since borrowing against the policy is a loan, it technically doesn’t count as income and does not have to be reported to the IRS. This is all while the life insurance aspect of the policy remains in full effect, meaning you still have total coverage in case of tragedy.

What if you don’t pay back the loan?

It’s important to recognize that if you borrow against the cash value of a universal life insurance policy, you’ll eventually need to pay it back. Failure to do so will cause the loan to be recharacterized as a withdrawal instead. From a tax perspective, this is very important. Unlike loans, withdrawals are considered taxable income. Therefore, it could trigger a tax bill resulting in thousands of dollars owed to the IRS.

Additionally, any money that’s borrowed against a universal life insurance policy and not repaid will be subtracted from the death benefits paid out to your beneficiaries. For instance, suppose you have a $1 million policy and borrowed $250,000 from the cash value. If you were to pass away suddenly, this outstanding balance would be subtracted from the death benefit. This would only leave your beneficiaries with $750,000. It’s important to point this out because it could have significant financial consequences if your loved ones expect to use this money as income replacement.

The bottom line

While it’s certainly possible to borrow against the universal life insurance policy, you’ll want to ensure it’s for the right reasons. Generally, people who utilize this strategy do so to pursue other financial opportunities, such as purchasing an income-producing asset or starting a new business venture.

Remember that the policy’s cash value will eventually need to be repaid. If not, it could be considered a taxable event and reduce the expected payout to your beneficiaries.