fbpx
borrow against life insurance - featured img

Borrow Against Life Insurance: Rapid Access in Canada

Getting your Trinity Audio player ready...

Are you wondering how soon you can borrow against life insurance in Canada? It’s important to know the timeline and requirements before making a life insurance loan.

In this article, we’ll explore how soon you can borrow against your policy and the factors that determine your eligibility. Understanding these details will help you make informed choices about utilizing your life insurance for financial needs. Keep reading to find out more about borrowing against your life insurance policy.

Key Takeaways

  • Cash-value life insurance policies (universal or whole life insurance policy) allow policyholders to borrow against their policies.
  • Policy loans use the death benefit and cash value of the policy as collateral.
  • Repaying the loan keeps the entire policy value intact while failing to repay deducts the outstanding balance from the death benefit.
  • A life insurance policy loan provides quicker access to cash than a bank loan.

How Does A Policy Loan Work

Policy loans allow you to access the cash value of your permanent life insurance policy without necessarily withdrawing it, or going through a credit check or a loan approval process. The maximum loan amount is determined by the cash value of your policy, and most insurers allow you to borrow up to 90% of that value.

One of the advantages of a policy loan is that there are no specific repayment timelines or mandatory monthly payments. You have the flexibility to choose from different repayment options, including making principal and interest payments on top of your regular monthly contributions, annual interest-only payments, or paying the whole amount owing in a lump sum. However, it’s important to note that if the loan isn’t repaid, it can have a significant impact on your policy’s cash surrender value. The outstanding balance, including accrued interest, will be deducted from the death benefit, reducing the amount your beneficiaries receive.

Additionally, it’s important to consider the tax implications of a policy loan. As long as the loan amount doesn’t exceed the policy’s adjusted cost basis or ACB, the policy remains in force, the loan balance isn’t subject to tax. However, if the policy lapses, the cash taken out may be treated as a taxable disposition.

Why You Can Borrow

When you look at your life insurance as an asset class, instead of simply looking at it as a financial safety net in case of premature death, it will be a bit easier to absorb why borrowing from your life insurance is a viable option, and why most wealthy families have been doing this for years. The easiest way is to look at it as an asset class that’s similar to your home or a real estate investment; where, while you’re making your monthly contributions, you’re building your equity at the same time. Hence, the short answer is – because it’s an asset!

When you have an asset, there are different ways you can access cash from that asset – the most obvious way, of course, is asset disposition, or by selling the asset. When you dispose of the asset, you no longer own it. The beauty of simply borrowing against your policy instead of withdrawing funds directly or “cashing out” your policy is the fact that you’re not disposing of the asset. This means, that while you’re borrowing, your wealth inside the policy continues to grow, especially in the case of participating whole life policies. With par whole life, you’re not necessarily invested in the market, what makes your equity or cash values grow are the annual policy dividends that the dividends earn regardless of whether or not the markets are down or up. 

How Soon Can You Borrow

As soon as your life insurance policy has accumulated enough cash value, you can borrow against it. The time frame for building up enough cash value varies depending on the policy type and insurer. Generally, it takes about 2 to 5 years for the cash value to start accruing, and it may take around 10 years to see a substantial amount of accumulated cash value. Note that it would also depend on how much money you’re putting away into your policy. 

Also, note that not all policies are eligible for policy loans. Hence, not all policyholders can borrow against their life insurance policies. As mentioned, there are specific types of life insurance policies that are highly suitable for policy loans, and not every Canadian insurance provider offers such a life insurance plan.

To be eligible, you must have either a participating whole life or universal life insurance policy that builds cash value. Term life insurance policies don’t have a cash value component and can’t be borrowed against.

The loan amount you can borrow against your life insurance policy typically ranges up to 90% of the cash value. However, the exact percentage and minimum cash value requirements can vary between insurers. Interest rates on life insurance loans are generally lower compared to other types of loans such as personal loans, or a line of credit, and repayment options are more flexible, however, again, like any other collateral loans, not repaying the loan can have consequences. Therefore, it’s crucial to carefully consider your repayment options and ensure timely repayments to maintain the integrity of your life insurance coverage.

Advantages of Borrowing

One advantage of borrowing against your life insurance policy is the ability to access funds quickly and easily. When you need cash urgently, borrowing against your policy can provide a convenient solution. Here are a few advantages to consider:

  • Quick access to funds: Unlike traditional loans that may involve lengthy approval processes, borrowing from your life insurance policy allows for quick access to the funds you need. In some cases, the funds can be deposited into your account within a few days.

  • Lower loan interest rates: Life insurance policy loans often come with lower interest rates compared to other types of loans. This is because the loan is secured by the cash value of your policy, reducing the risk for the lender.

  • No credit requirements: Unlike traditional loans that typically require credit checks and income verification, borrowing against your life insurance policy doesn’t have any credit requirements. This means that your credit score doesn’t impact loan approval or interest rates.

  • Minimal tax implications: As long as the loan balance doesn’t exceed the policy’s ACB, and your policy remains in force, you won’t have to worry about tax implications.

Disadvantages of Borrowing

While borrowing against your life insurance policy can provide quick access to funds, there are several potential disadvantages to consider.

One disadvantage is the tax implications. If you fail to repay the loan and the loan balance catches up with your policy’s adjusted cost base or ACB, the money taken out as policy loans, may be treated as deemed disposition of the policy.

Another disadvantage is the potential negative impact on the death benefit. If you fail to pay back the policy loan (money you borrowed from the insurance company, collateralized by your policy’s cash values), the interest will compound over time, which means that the loan amount will grow, and this eventually might catch up with your cash values. Keep in mind that policy loans need to be repaid. If you never paid back the loan, then there’s a risk of policy lapse. If the accumulated interest causes the loan balance to exceed the cash value, it can lead to a lapse in insurance coverage.

Repayment options can also be a disadvantage as there’s no predefined repayment period for policy loans, requiring regular payments to pay down the loan. As the borrower, it’s your responsibility to set your preferred payment option, to make sure that the policy loan is paid back so as not to affect your policy’s cash value account.

Lastly, if your policy doesn’t have cash values, you can’t borrow against the policy, so you must wait until you have enough cash values accumulated before applying for borrowing against your policy.

Things to Consider Before Borrowing

Before borrowing against your life insurance policy, there are important factors to consider. Here are some key points to keep in mind:

  • Pros and cons: It’s essential to weigh the advantages and disadvantages of borrowing from your life insurance policy. While it provides quick access to cash without the need for a credit check, failing to repay the loan can lower the death benefit and potentially cause the policy to lapse.

  • Loan eligibility: Check if your policy has a cash value component, as only permanent life insurance policies with cash value can be borrowed against. Additionally, different insurers have varying rules on the minimum cash value and the percentage that can be borrowed.

  • Tax implications: Generally, funds borrowed from a life insurance policy are tax-free. However, if the loan isn’t repaid and the policy lapses, the cash taken out may be treated as taxable income.

  • Impact on death benefit: Borrowing against your policy reduces the death benefit. If the loan isn’t repaid, the outstanding balance will be deducted from the death benefit received by your beneficiaries.

  • Repayment options: Policy loans offer flexibility in repayment. You can choose between making principal payments with interest, interest-only payments, or deducting interest from the cash value. However, it’s crucial to establish a repayment schedule to avoid significant interest accrual.

Considering these factors will help you make an informed decision about borrowing against your life insurance policy.

Borrowing Against Your Policy

You can start borrowing against your life insurance policy as soon as there is enough cash value built up. The eligibility requirements for borrowing vary between insurers, but generally, cash value must accumulate in whole or universal life insurance policies before borrowing is allowed. Different insurers have varying rules on the minimum cash value and the percentage that can be borrowed. The time it takes for a policy to be eligible for a loan depends on the policy type, with cash value typically accruing in 2 to 5 years and becoming available for borrowing in about 10 years.

When it comes to borrowing against your policy, it’s important to consider the interest rates, loan repayment options, tax implications, and the impact on the death benefit. Interest rates on policy loans are typically lower than bank loans or credit cards, making it a favorable option. Repayment options include making principal payments with interest, paying interest-only, or deducting the interest from the cash value. However, if the loan is not repaid before death, the death benefit will be reduced, potentially putting the policy at risk of not providing sufficient funds to beneficiaries.

Key Considerations 
Eligibility RequirementsVaries by insurer
Interest RatesLower than bank loans
Loan Repayment OptionsPrincipal payments with interest, interest-only payments, deducting interest from cash value
Tax ImplicationsTax-free funding source recognized by the IRS
Impact on Death BenefitReduced if loan is not repaid before death

Ways to Pay Back Your Policy Loan

One way to repay your policy loan is by making regular payments on top of your policy’s regular contribution, making a lump sum payment within the year you borrowed, or paying interest only on an annual basis until you’re ready to pay the principal. 

Below are four important things to consider when planning your policy loan repayment:

  • Interest rates: Your policy loan will accrue interest over time. It’s important to be aware of the interest rate on your loan and factor it into your repayment plan. Lower interest rates can help you save money in the long run.

  • Consequences of not repaying: Failing to repay your policy loan can have serious consequences. If the loan isn’t repaid, the outstanding balance will be deducted from the death benefit, reducing the amount paid out to your beneficiaries. Additionally, if the loan balance exceeds the cash value, it could lead to a lapse in insurance coverage.

  • Benefits of timely repayment: Timely repayment of your policy loan has several benefits. It helps to keep the entire value of your policy intact, ensuring that your beneficiaries receive the full death benefit. It also helps to avoid the accumulation of interest, which can increase the overall cost of the loan.

  • Tax implications: It’s important to consider the tax implications of your policy loan. Generally, the loan itself isn’t taxable as long as it doesn’t exceed the premiums paid and the policy is in force. However, if the policy lapses and the cash taken out is treated as taxable income, it could result in additional tax obligations.

Best Type of Life Insurance for Policy Loans

Choosing the right type of life insurance policy is crucial when considering borrowing against it. When it comes to policy loans, the best type of life insurance to consider is participating whole life insurance or universal life insurance. These types of policies have a cash value component that grows over time, providing assets that you can borrow against.

Personally, I gear toward participating whole life insurance but universal life insurance works as well. The only difference is the fact that your policy will continue earning policy dividends while you’re borrowing, so you benefit from uninterrupted wealth-building, regardless of market conditions, or when you’re collateralizing your policy. When you collateralize a universal life insurance policy, you will be asked to move your policy’s underlying investment portfolios into fixed-income instruments such as a high-interest savings account, which will give you between 1% to 2%. As such, you will deal with opportunity costs each time you’re borrowing because you have to pull your policy’s portfolio out of the market since the insurance company will not lend you if your collateral values fluctuate, and neither will any banking institutions in terms of bank collateral loans.

Frequently Asked Questions

Can I Borrow Against a Term Life Insurance Policy?

Term policies don’t have a cash value component, so you can’t borrow against the cash value.

Instead, you may be able to convert your term policy to a participating whole life or universal life policy, which would allow you to borrow against the cash value.

How Does Borrowing Against a Life Insurance Policy Affect the Death Benefit?

Borrowing against a life insurance policy can impact the death benefit by reducing it if the loan isn’t repaid. The loan also accrues interest, which can affect the overall cost of borrowing. Repayment options and terms vary, allowing flexibility in how you choose to pay back the loan.

Are There Any Tax Implications When Borrowing Against a Life Insurance Policy?

When you borrow against a life insurance policy, there are tax implications to consider. The loan itself isn’t subject to tax as long as it doesn’t exceed the policy’s adjusted cost basis, and the policy remains active.

What Happens if I Don’t Repay the Loan Against My Life Insurance Policy?

If you don’t repay the loan against your life insurance policy, there can be significant consequences. The outstanding balance, including accrued interest, will be deducted from the death benefit, reducing the amount your beneficiaries receive. The policy may lapse if the loan balance exceeds the cash value, resulting in a loss of coverage.

How Long Does It Typically Take to Build Enough Cash Value in a Life Insurance Policy to Be Eligible for a Loan?

The speed of cash value growth depends on factors like the type of policy and the cash value growth rate.

To accelerate cash value growth, you can consider strategies like paying higher premiums or investing in policies with higher cash value growth potential.

Conclusion

Borrowing against a life insurance policy can be a useful option for accessing cash when needed.

The ability to borrow depends on the type of policy you have, such as cash-value life insurance.

It’s important to carefully consider the advantages and disadvantages before making a decision. Understanding repayment options is crucial.

Ultimately, borrowing against your life insurance policy can be a valuable tool, but it should be done with caution and careful consideration of your individual circumstances.

Contact us for your Financial Services Needs

At SmartWealth, we provide expert advice for insurance, savings, and retirement planning. As your Insurance and financial advisor, we work with you to create a personalized plan for your family or business that covers and meets your needs.

To schedule a consultation about your financial goals, or if you have any questions about insurance in Alberta, Manitoba, or Ontario, please book a virtual meeting to talk to an advisor today! We’re proudly based out of Winnipeg and service clients anywhere in Ontario, Manitoba and Alberta, including Guelph, Edmonton, and Brandon.

Leave a Comment

Your email address will not be published. Required fields are marked *

Scroll to Top