Universal life insurance allows policyholders to access cash value through policy loans and withdrawals. While both provide liquidity, they function differently and have distinct effects on cash value, death benefits, and long-term policy sustainability.
Understanding these differences is essential before accessing policy funds.
What a Policy Loan Is
A policy loan allows the policyholder to borrow against the policy’s cash value. The insurer lends funds using the cash value as collateral.
Key characteristics include:
- No credit check
- No required repayment schedule
- Interest accrues on the loan balance
Unpaid loans reduce the death benefit at death.
What a Cash Value Withdrawal Is
A withdrawal permanently removes a portion of the policy’s cash value.
Withdrawals:
- Reduce cash value immediately
- Usually reduce the death benefit
- Do not require repayment
Once withdrawn, the funds and their future growth are permanently removed from the policy.
Impact on Cash Value
Loans
- Reduce the amount of cash value available to support policy charges
- May slow growth depending on crediting rules
- Increase lapse risk if loan balances grow
Withdrawals
- Permanently lower cash value
- Eliminate future growth on withdrawn amounts
- Can weaken policy sustainability more quickly
Both methods reduce the buffer that protects against rising costs.
Impact on Policy Charges and Lapse Risk
When cash value is reduced:
- Monthly policy charges remain unchanged
- Less value is available to cover costs
- Premiums may need to increase
Excessive loans or withdrawals are a common contributor to policy lapse.
Tax Considerations
Loans are generally not taxable as long as the policy remains in force.
Withdrawals:
- Are typically tax-free up to cost basis
- May be taxable above cost basis
- Can create tax liability if the policy lapses
Tax treatment depends on policy structure and usage.
Interest Accrual on Loans
Loan interest accrues over time and is added to the loan balance if unpaid. Growing loan balances:
- Reduce net death benefit
- Increase lapse risk
- May require repayment to stabilize the policy
Interest rates are defined in the policy contract.
Using Loans and Withdrawals Strategically
Loans and withdrawals may be used for:
- Temporary cash flow needs
- Emergency expenses
- Planned retirement income supplementation
They are most effective when part of a deliberate strategy rather than ongoing reliance.
Monitoring After Accessing Funds
After taking loans or withdrawals, policyholders should:
- Review updated projections
- Monitor cash value trends
- Adjust premiums if needed
Failing to reassess policy performance can accelerate lapse risk.
Key Takeaways
Universal life insurance loans and withdrawals provide access to cash value but directly affect policy performance. Responsible use requires understanding long-term impacts, managing loan balances, and actively monitoring policy sustainability.
Related Guides