Is Borrowing Against Life Insurance Risky?

Is borrowing against life insurance risky? Well, borrowing against life insurance can be very useful, but it does carry some risks if you don't manage the loan and interest carefully. This is something that one of the originators of the infinite banking idea, Nelson Nash, took very seriously; he talked about being an honest banker with your policy loans.

When you take a policy loan, the insurer lends you money using your cash value as collateral. If you don't pay it, the loan plus interest grows and is deducted from your death benefit, meaning that your beneficiaries receive less. In some cases, this is strategically planned to draw down that death benefit. If the loan balance and interest ever approach or exceed the available cash value, the policy could lapse, though companies keep tabs on this. At that point, the IRS could treat the outstanding loan as taxable income to the extent of gain, creating a surprise tax bill and loss of coverage. Used with a clear repayment strategy and clear monitoring, loans can be relatively low risk. Used casually, they're pretty safe when calculated and it's understood that you want to manage repayment prudently.

So the takeaway here: policy loans aren't automatically bad, but they are debt from the standpoint that they cut into the death benefit and can threaten the policy if not paid for a long period of time.

Three takeaways. One, loans reduce available cash value and will lower the death benefit dollar for dollar if not repaid. Number two, if the loan plus interest grows too large and the policy lapses or is surrendered, any gain above what you paid in can become taxable. Number three, with properly designed policies, monitoring, and a disciplined repayment plan, borrowing can be a flexible, highly tax-advantaged tool, but it should never be treated as free money unless, of course, you're in a particular strategy like tax-free retirement where that is in the cards from a planning standpoint.

Lots more on this, but for related glossary links, you can look at policy loans, cash value life insurance, policy lapse, loan interest, taxable gain. Thanks for watching.