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What are the pros and cons of borrowing against my insurance policy?
Borrowing against the built-up value of a cash-value life insurance policy has several advantages. Rates are usually lower than on bank loans, no credit check is required, and loan approval is virtually guaranteed because you are borrowing against your own money.
On the other hand, the loan reduces the amount of money your heirs get if you die before you repay the loan. And there’s the irritation of knowing that you’re paying interest to use your own money.Can I deduct interest on a loan I take out against my life insurance policy?
You can deduct the interest on a life insurance loan if you use the money for a deductible purpose. For example, if you use the proceeds to buy investment property such as stocks and bonds, you can deduct interest up the amount of your investment income less other investment expenses. You can carry forward any amount disallowed under this rule to future years.
You must pay the interest to the insurance company -- it doesn’t count if the insurance company adds the interest to your debt. And you can’t deduct interest after you assign the policy to someone else.Does it make sense to borrow against my life insurance policy to fund a college education?
It can make sense because the rate on a policy loan is likely to be lower than you might otherwise be able to obtain. And you don’t have to go through an application process. Before you take out a policy loan, however, be sure to consider your long-term life insurance needs. And be careful that you do not inadvertently borrow so much money that the insurance company decides to terminate the policy. That could sock you with an unexpected and large capital gain tax. How do I access the cash value of my life insurance at retirement?
After you retire, there are several ways to turn the built-up cash value of your life insurance into cash, including:
- You can withdraw your basis free of tax. Your basis is the amount of premiums you paid, less any withdrawals you have made.
- You can take a policy loan. Loans are not generally taxable because they are an advance of the death benefit.
- You can combine both techniques. Often, a combination of withdrawing your basis down to zero and then borrowing the remainder gives the best results. If you let the policy lapse with the basis withdrawn and a full loan outstanding, you may face a significant tax bill.
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