You can access money in a permanent life insurance policy in several ways without cancelling it. Borrowing against life insurance, withdrawing from it, and taking out a loan using the policy as collateral are three distinct transactions, each with different impacts on your policy’s cash value and death benefit.
This guide draws on the Financial Consumer Agency of Canada’s life-insurance guide, section 148 of the Income Tax Act, and the Canada Revenue Agency’s policy-loan interest guidance to answer the following questions:
- Which life insurance policies have cash value
- How you can use your life insurance to borrow money
- Important figures you should ask about before deciding how to access your money
- How using your cash value can cost more than expected, thanks to policy-loan interest, policy-lapse risk and taxes
Is Borrowing Against Life Insurance A Good Idea?
Loans may make sense when a policy has adequate cash value, you have a short-term or well-defined financial need, and borrowing costs don’t put premiums and coverage at risk.
Loans may not make sense when they’re used to cover chronic cash-flow shortfalls, the policy isn’t adequately funded, or your beneficiaries count on receiving the full amount of your insurance.
Assessing a life insurance loan is complicated. The interest rate is not everything. Compare future policy values, interest calculations, after-tax proceeds, repayment options, and effects on beneficiaries across policy loans, other credit sources, and partial withdrawals.
Which Life Insurance Policies Support Loans?
A bank may accept an eligible permanent life insurance policy as collateral for a loan. These loans require bank credit approval and include terms and conditions for repayment. In addition, the policyholder must execute a collateral assignment. The bank provides the loan, not the insurer.
Some whole life and universal life insurance policies accumulate a cash value and may allow the policyholder to take a loan or withdrawal. The timing and amount of a policy loan depend on the life insurance policy’s contract and its cash values. Term life insurance does not build a cash value and cannot be used for a policy loan.
Read More: See How Whole Life Insurance Works
Three Ways To Access Policy Value
| Method | What happens | Main risk to compare |
|---|---|---|
| Direct policy loan | Policy value: The insurer can give an advance against the value of the policy. Interest accrues on this amount. | Consequences of accessing policy value can include a taxable amount, increasing balances, a smaller death benefit or a policy lapse. |
| Withdrawal or partial surrender | In this case, cash leaves the policy permanently and does not need repayment. | Consider permanent reduction, surrender charges and a taxable policy gain |
| Collateral bank loan | Collateral assignment: a lender gives you money in exchange for a security interest in the policy. | Considerations: credit approval, variable interest, required payments and lender rights under the collateral assignment |
Read More: See How Cash Value Can Be Withdrawn From Life Insurance
How Much Can You Borrow From Your Life Insurance Policy?
There is no reliable national percentage for how much you can borrow; ask your insurer for an in-force illustration and current policy statement showing your policy’s available amount. Ask for five key numbers as of the same date: cash surrender value, adjusted cost basis, maximum loan, current interest rate and projected death benefit after the proposed transaction.
Some insurers won’t let you borrow your entire cash surrender value because they need to ensure your policy stays in force, taking into account any interest and/or charges, as well as possible changes in investment performance where applicable. If you use your policy as collateral with a lender, they may use a different advance rate.
Pros And Cons Of Borrowing Against Life Insurance
| Possible advantage | Trade-off |
|---|---|
| No new medical underwriting: A direct policy loan doesn’t require medical underwriting. | Note that you can only take a loan against a policy if there is accessible cash value. |
| Borrowing against your life insurance policy may eliminate the need to liquidate other assets. | Loans against life insurance accrue interest. Be aware that interest costs could outweigh the value of keeping this asset. |
| Depending on the terms of the policy, flexible repayment options may be available. | Unpaid interest can compound. This could put your life insurance policy at risk of lapsing. |
| If you manage the policy loan properly, your coverage can remain intact. | Having an outstanding balance on a policy loan can reduce the death benefit as well as any accumulated cash value in your policy. |
Canadian Tax Rules To Check Before Taking Cash
Policy loan – Under s. 148 of the Income Tax Act, a policy loan is considered to be a disposition of the policy. Any part of the policy loan in excess of the policy’s adjusted cost basis would be included in income. A withdrawal or surrender is also a disposition of a policy and may have its own tax calculation.
Interest paid on a life insurance policy loan for personal use is generally not tax-deductible. However, under certain conditions, the CRA allows this interest to be deductible when the funds are used to earn income from a business or property. Your insurer can verify the amount of interest paid on your policy loan on Form T2210, but whether a deduction is available depends on the applicable tax conditions.
Assigning your policy – Assigning your policy as security for a loan, other than a policy loan, does not fall under the definition of disposition under s.148 of the Act. However, there may be tax consequences on a later event, such as surrendering the policy, allowing the policy to lapse, or transferring the policy.
Ask the insurer to provide you with a calculation of the taxable portion of the transaction.
For material transactions, or in the case of a business-owned policy, we would recommend obtaining advice from a qualified tax professional.
Read More: Review Canadian Tax Rules for Life Insurance Cash and Payouts
How Does Borrowing Affect Cash Value And The Death Benefit?
A policy loan, plus any interest, can reduce the amount paid at surrender or at death.
Assume, for example, a policy that will pay a death benefit of $500,000 and a policyholder who has an $80,000 loan and $10,000 of interest. In that case, both amounts would be deducted from the death benefit, leaving a benefit of $410,000 before any other contractual additions and deductions. Again, this is only an example and should not be considered a promise that the benefit would equal that exact amount.
Policy Loans Vs Other Borrowing Options
| Option | Approval and repayment | Cost to compare | Asset or policy risk |
|---|---|---|---|
| Policy loan | Policy loans are typically based on the policy’s contract value. Repayment conditions vary. | Quoted rate, compounding and possible tax implications. | Death benefit, surrender value and lapse |
| Collateral bank loan | This option requires lender credit approval and has scheduled or demand terms. | Lender rate, fees and tax advice | What are the lender’s rights under assignment of the policy? |
| Personal loan or line of credit | Other borrowing options include a review of your credit and income. | APR, fees and payment schedule. | Credit impact and collection |
| Home-secured credit | Home-secured credit approval considers credit, income and property. | Variable rate, fees and required payments | Home represents security. |
Which Borrowing Method Fits The Need?
Have a definite plan for either limiting or paying off the policy-loan balance. Otherwise, you may be shifting your current problem onto your policy and your beneficiaries.
Compare the written offers of lenders for the same amount of money for the same length of time. Include interest, fees, the impact of reduced policy benefits, tax effects and compounding in determining the best offer.
Should You Borrow Against Your Life Insurance?
- Ask for an in-force illustration with no loan as well as one including the loan, using current and less favourable interest and investment return assumptions
- Ascertain the current ACB, cash surrender value, maximum loan, loan interest rate and compounding frequency, loan repayment provisions, and circumstances under which the policy will lapse
- Ascertain whether you need the consent of an irrevocable beneficiary, collateral assignee, or co-owner
- Compare the amount you’ll receive and the cost of a policy loan with other borrowing options such as a policy withdrawal, personal or secured credit, over a common time horizon
- Set reminders to review the loan at least annually, paying particular attention to the outstanding loan balance, compounding interest, other charges, and likelihood of lapse.
Read More: Compare Borrowing With Cashing Out a Life Insurance Policy