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Taking A Loan From Your Life Insurance Can Be Dangerous To Your Plans

Everyone, including retirees, finds the need for some extra money at one point or another

. Those who have life insurance may consider taking a loan from it. The equity component of whole life insurance polices - especially variable universal life - presents a store of savings that you can access in time of need. Though borrowing against your insurance policy may be an attractive option, be aware of the danger it presents to your plans.

The equity portion of your universal life policy comes from a portion of your premiums and its gains earned in its associated stock and bond portfolios. These grew out of the portion of your premium payments that went into your policy's cash value - and not into payments for your 'pure' insurance.

One of life insurance's tax advantages is that those investment gains grow tax-deferred. If the cash value is never withdrawn, all gains will be tax free, and the policy benefit at your death is free of all income tax to the beneficiary. But if you directly and permanently withdrew from your insurance policy, you'll incur income tax on its investment gains. And income tax rates run up as high as 35% or more.

Taking a loan against your life insurance presents a way to access that equity with no apparent tax consequences if you're intention is to pay it back. In fact, life insurance represents a source of low interest loans compared to a typical bank loan. That's because it's a secured loan backed by the equity you have in your policy. And, money from a loan is not considered income - and, therefore, not taxable. That's another advantage of equity based life insurance.

*But the danger is there...

Your life insurance loan remains a loan as long as you maintain your policy 'in force'. And that'll be true as long as you keep paying your premium payments.

But if you stop making timely payments while you're living - i.e. letting your policy lapse - then that loan turns into a direct withdrawal. And that immediately triggers all the income tax due on what you received as loan money. That can put you into a tax nightmare with the IRS.

Such a circumstance is not out of the question if you borrowed from your policy when you were in serious need of money. If so, you may also be unable to maintain loan and premiums payments as they come due.

Taking a loan against your life insurance is best reserved for the special circumstance when you're able to make any and all payments, but would like a low cost loan which you can pay back easily in the near future.

Buy and maintain your life insurance for the reasons associated with your death. That's its principal function - and for which it's best designed.

by: Shane Flait
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Taking A Loan From Your Life Insurance Can Be Dangerous To Your Plans Washington