How a policy loan actually works
Once a whole life policy has built up cash value, most insurers let you borrow against it — typically up to 100% of the available cash surrender value, depending on the insurer. There's no credit check and no medical exam, since the loan is secured by value already inside your own policy. The money can be used for anything: a business opportunity, a down payment, an emergency, or simply supplementing retirement income.
Crucially, a policy loan isn't a withdrawal — your cash value isn't being removed from the policy, it's being used as collateral while the insurer lends you money against it. That distinction matters for how it's taxed, which we'll get to below.
What it costs
Policy loans aren't free money. Interest accrues on the outstanding balance at a rate set in your contract — fixed or variable depending on the insurer — and if it isn't paid, it compounds and gets added to the loan balance. Left unpaid for several years, a loan can grow substantially: a $50,000 loan at 8% interest can grow to $65,000 or more if simply left to accumulate, which eats directly into the death benefit your beneficiaries would otherwise receive.
Some banks also offer a separate type of loan — a collateral loan against your policy, priced closer to typical lending rates — as an alternative to borrowing directly from the insurer. It's worth comparing both options before choosing.
The tax treatment, in plain terms
This is the part people get wrong most often:
- Borrowing is not taxable while the policy remains in force — taking out a loan itself doesn't trigger income tax.
- Tax arises on a "disposition" — surrendering the policy or letting it lapse — calculated as the cash value minus the policy's Adjusted Cost Basis (ACB), not the loan amount itself.
- The loan balance reduces what's left at surrender, lapse, or death, but it's the gain over ACB that's taxed, not the loan.
You can typically request your policy's current Adjusted Cost Basis from your insurer each year — it's worth knowing before you borrow, not after.
Thinking about borrowing from a policy? Let's look at what it would actually cost you, long-term.
Book a CallThe real risk: an unpaid loan causing a lapse
If an outstanding loan plus accumulated interest grows large enough to approach or exceed the policy's cash value, the policy can lapse — ending your coverage and triggering a taxable disposition (the cash value at lapse minus the Adjusted Cost Basis becomes taxable income) at the worst possible moment, often when the person can least afford an unexpected tax bill. Insurers are generally required to send warning notices before this happens, but it's a risk that's entirely avoidable with a plan to manage the loan.
Before you borrow, ask these questions
- What's the current interest rate, and is it fixed or variable?
- Do I have a realistic plan to repay it, or am I comfortable with it reducing my death benefit permanently?
- Have I checked my policy's current Adjusted Cost Basis, to understand the tax exposure if I ever surrender or lapse?
- Would a bank loan, line of credit, or a collateral loan against the policy (rather than borrowing directly from the insurer) be cheaper?
