Should you borrow from your life insurance?
You have heard your friends talking about it and now you are wondering if you can also borrow from your life insurance. Slow down, times may be tough now, but using your life insurance as your source of income may not be the best thing to do.
How do you borrow from your life insurance?
There are three forms of borrowing in relation to life policies, according to Jan van der Merwe, head of actuarial and product at PSG Wealth.
Withdraw from the life policy
Some life insurance companies allow you to take a loan on the policy itself, but this is generally just a withdrawal from the amount already saved in the policy. It is simply structured as a loan to allow early withdrawal from an endowment type policy.
Insurers generally allow the owners of the policies to withdraw an amount equal to the cash value of their policy, subject to certain restrictions..
“In general, the cash value is the accumulated value of all premiums (i.e. contributions made) less all withdrawals and charges,” says Van der Merwe.
According to him, there are many different forms of life insurance policies, and they all offer different benefits and features.
“Because of this, different companies may have different definitions of ‘cash value’,” he says.
The cash value may be different from the “sum insured” if the policy provides insurance on death, disability or critical illness. Cash values may also be different to “paid up” values, where “paid up” means that the policy continues, but premiums cease.
Borrow against the cash value of the policy
A life policy (that has a savings value) may technically be used as security for a loan from a bank or another credit providing institution (e.g. this is similar conceptually to using your house as security for the bond). However, this practice is not common in South Africa.
Banks issue personal loans based on overall client assets, debt and earnings, and not so much based on a single life policy asset.
Cession of the policy
Some life policies only provide risk cover (and no savings benefit) and therefore such a policy cannot be used to borrow against. It may however be required by the bank if they’ve issued you a loan and want some form of protection should the borrower die.
Keep in mind that you cannot use a retirement annuity type policy as security against a loan.
What are the consequences of borrowing from your life insurance?
You run the risk of having to use the policy (i.e. cash it in) if you’re not able to pay back your debt out of your monthly earnings. Hence, as always, it’s best to try your best not to borrow money (at least not for general expenditure), but to rather save in advance.
Before you borrow from your life insurance, consult your adviser.
This article has been prepared for information purposes only and it does not constitute legal, financial, or medical advice. The publication, journalist, and companies or individuals providing commentary cannot be held liable in any way. Readers are advised to seek legal, financial, or medical advice where appropriate.