Policy Loans: Loan Implications

It can be tempting to tap into the cash value of a life insurance policy that has been accumulating for many years. However, unlike normal investment accounts, accessing life insurance cash value is not a straightforward process. There are three ways to access your cash value: surrender, policy loan, or a secured loan. Each method has implications that should be fully understood as they can have a serious impact on your tax bill.

Over this series of articles, we will look at defining these methods as well as exploring their implications.

We previously looked at the definition of Policy Loans. Now – what about the implications of using this method to access your cash value?

Tax Implications
Policy loans have similar tax implications to surrendering a life insurance policy. Any amount loaned above the ACB is taxable income to the policy owner.

Interest on policy loans may also be deductible to the policy owner if the funds are being used to earn income in business or a property.

Policy Implications
Policy loans allow access to the cash value without cancelling the policy outright, however if the loan remains outstanding at the time of the insured death then the death benefit will be reduced by the total amount of the loan at that time. It is also important to understand that while policy owners are not required to make payments back into the policy, it is possible that the interest accumulates to a point that the policy can no longer sustain itself. In this situation it may be required that the policy owner start making payments into the policy to cover the interest or the policy may be at risk of lapsing.

It is always best to consult a professional before making any decisions regarding your policies cash value. Not only are there tax implications that need to be considered, additional income can affect government benefits and should therefore be taken strategically.

Definitions

ACB – Adjusted Cost Basis
The ACB of the policy is the sum of the premiums paid into the policy minus the actual cost of the insurance policy or NCPI (Net cost of Pure insurance). Similar to the purchase price of a stock or a building to ensure that your original capital does not get taxed again.

Lapsing
This means that your policy loan now exceeds your policies cash value causing your policy to be in jeopardy of being cancelled. If a premium is not paid within 30 days, the policy will be cancelled.

CSV – Cash Surrender Value
The CSV is the value that the policy owner would receive if they cancelled their permanent life insurance policy.