If I borrow from my Whole Life insurance cash value do I still earn on the full amount?
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Asked November 29, 2011
The simple answer is "No," but the question deserves a bit more explanation. Whole life insurance policies make a great financial tool, but they are not a magic earnings machine. The accrued value in the policy comes from two sources: your payments into the policy and interest, if any, earned against that accrued value. When you borrow against the policy, you can only borrow against the accrued portion, that is, the portion of money you have paid in that was over and above administrative fees plus the amount of interest that money has earned.
If you had accrued $1000 in the policy, and you borrowed $800, that $800 would be removed from the accrued value of the policy until such time as it had been paid back in. As you begin to pack back the loan you made to yourself, the cash value of the policy would increase faster, because you are paying back the original amount and still paying premiums to increase the cash value, plus earning interest on the amount that is in the account. But the cash value would drop to $200 as soon as you borrowed $800, and would only increase slowly.
Some life insurance policies allow you to borrow against the value, and others allow you to withdraw from the cash value. If you borrowed against the cash value, you probably have to pay interest on that loan, the same as you would pay interest on a bank loan. That means you would lose a percentage of the money you pay back, which translates into having to pay more than $800 back into the account just to reach the original $1000 value again.
That is an important thing to know about life insurance. It is there if you need it, and you can borrow against it tax free because it is technically your money, but you still have to pay the interest to the lending institution, which in this case would be the insurance company which manages the policy. So borrowing against your policy works, but isn't a great deal cheaper than a bank loan.
Answered November 29, 2011 by Anonymous