What Is A Universal Life Policy?
One of the first things you're going to want to know is how to borrow against a universal life insurance policy, once you've got yours all set up. Universal Life (UL) was the brainchild of E.F. Hutton in the 1980s. This policy type was to replace whole life as the best life insurance policy contract type on the market. A whole life policy at that time was suffering from the low interest rate environment of the 1970s. Critics of whole life argued that it was beyond its prime.
Brokerage firms sought to capitalize on this by creating the very first "buy term and invest the difference" policy. Before that time, you had two options. You could buy whole life insurance or you could buy a term policy and invest what you saved from the cost of the whole life into some kind of investment.
Universal life offered a way to do both. Policyholders funded the contract and the premiums went straight into the cash value account. The insurer then deducted the cost of the death benefit from the policy. They would add interest to the account and whatever was left was the cash value available for borrowing.
Universal life promised higher interest rate returns than whole life, and they fulfilled that promise for a while. Eventually, the high interest rates of the 80s ended and Universal Life policies designed for these rates could not sustain the high costs built into them at that time.
These policies have seen a resurgence in popularity with new policy features and interest crediting strategies, but you should understand how to borrow against a universal life insurance policy, just in case another 1980s debacle occurs.
- Get out your life insurance policy contract. It'll have your policy number printed on there somewhere. Otherwise, dig out your last premium bill. It's on there too.
- Call your insurance company. Their phone number's in the book, on the web and on your premium bills.
- Speak to a company representative about taking out a loan from your policy. Taking out a policy loan is pretty simple. The insurance company doesn't require a loan application. You just need to tell them you want some money from the policy.
- Tell them where to send the money. Your insurer will either deposit the check directly into your bank account or they'll send you a check. What they do depends on the information they have. If you want direct deposit, you'll have to fill out a direct deposit form with them and give them your bank details. Otherwise, cash the check they send and you're good to go.
Taking out a loan from a universal life policy is fairly safe. But there's a few caveats. Life insurers charge interest on policy loans. These loans are income tax-free because of the fact that it's a loan you're taking and not profits from the policy.
Unless your policy contract specifically states that policy loans are a net zero cost to you, assume you're being charged interest on the loan. You don't have to make loan repayments on your policy, but if there is an interest charge, then interest will accumulate against the policy's remaining cash value. When there's no more cash value available to borrow against, the game's over. Your policy terminates.
The IRS will expect you to pay income tax on all of the money you received from the policy which exceeded the premiums you paid into the policy. Most life insurers are pretty good about warning you before your policy is about to terminate. Some even have provisions to suspend borrowing activity and they convert the policy to a paid up contract that you cannot borrow from anymore but which will save you from getting whacked with a huge tax bill.
Just make sure you understand how to borrow against a universal life insurance policy and what your insurer will and will not do for you in regards to these loans before you take one out.