Financial Answer Center

Certain types of life insurance policies include a savings component, or cash value. You may borrow against the accumulated cash value at relatively low interest rates. Essentially, you are borrowing from your own savings. Interest rates may be fixed or variable depending on the policy. Be sure to ask your insurance agent if the dividend rate will be reduced when you take out a loan. Also ask them to send you information regarding the loan provisions so you will fully understand all the implications of your loan. Provisions will vary with different policies and insurance companies.

Life insurance loans can be a convenient way to borrow money, especially if the interest rate is low. These loans can be, but do not have to be, repaid. However, interest on the loan is due on each policy anniversary. If the interest is not paid when due, it will be added to the loan, and any outstanding loan balance will be deducted from the death benefit your beneficiary will receive when you die. It is important that you at least pay the interest as it comes due, since interest will continue to accrue on the interest owed on the loan, resulting in a compounding effect. If the policy loan is still outstanding when the policy is surrendered or lapses, there may be income tax consequences.

IMPORTANT NOTE: If you use the cash value in your insurance policy to pay the interest on a life insurance loan, you may use up all of your cash value, which can cause your policy to lapse.

Is the Interest Tax-Deductible?

Interest on life insurance loans is treated as non-deductible personal interest, with one exception: If you use the funds to purchase investments, the interest may be deducted as investment interest.

To qualify for this exception, you must meet the following criteria:

• The investment must be purchased with the actual money that was borrowed.
• The interest on the debt must actually be paid by you and not added to the debt.
• The investments cannot be tax-exempt securities.
• You may be required to show that the check received from the insurance company was deposited directly into a brokerage account to buy the investments.

The bottom line is that you must make sure you keep all supporting documentation, in order to prove to the IRS that the money was used specifically to purchase investments.