Loans and Withdrawals Can Reduce the Death Benefit and May Incur Fees — Plan These Actions Prudently

How Loans and Withdrawals Affect Your Life Insurance

Most people see life insurance as a safety net for their family, but what if it could also help you solve a financial problem today? For millions of people with the right type of policy, it can. The key is its cash value—a built-in savings component that grows over time and marks the fundamental difference between the two main types of life insurance.

A term policy is like renting; it provides pure protection for a set period. Permanent insurance, however, is like owning; part of your premium builds equity, known as the cash value of life insurance. This accessible fund is separate from the death benefit promised to your family.

Knowing which type of policy you have is the critical first step. Check your policy documents for keywords like Term, Whole Life, or Universal Life. Only permanent policies allow for policy loans or partial withdrawals, making this the most important detail to confirm before planning your next move.

How a Policy Loan Works: Borrowing From Yourself

When you need funds, a policy loan can feel like an easy solution. Instead of borrowing from a bank, you are borrowing against your policy’s cash value, with the policy itself acting as collateral. You are not borrowing the insurance company’s money—you are accessing a portion of the value you have already built.

However, this convenience is not entirely free. The outstanding loan balance accrues interest. If you do not pay the interest out of pocket, it is added to the loan balance, causing the total debt to grow over time.

Any unpaid loan balance, including accumulated interest, is deducted from the death benefit before your beneficiaries receive their payout. This makes a loan a flexible but temporary solution. For those who want to avoid interest, a partial withdrawal offers a different option.

What Is a Partial Withdrawal? The No-Interest, Permanent Option

If interest on a loan is a concern, a partial withdrawal provides another way to access cash value. Instead of borrowing, you permanently remove part of your cash value. It is similar to taking money from savings that you do not plan to replace.

This action has an immediate and permanent effect. A partial withdrawal from a whole life or universal life policy reduces both your available cash value and your death benefit permanently. Unlike a loan, withdrawals cannot be repaid to restore coverage.

The trade-off is clear: no interest, but a permanently lower payout to your beneficiaries.

How an Unpaid Loan Reduces Your Family’s Payout: A Simple Example

When a policyholder passes away, beneficiaries are not billed for unpaid policy loans. Instead, the insurance company deducts the loan balance directly from the death benefit.

For example, if you have a $250,000 policy and took out a $20,000 loan that accrued $1,500 in interest, the insurer subtracts both amounts.

Final payout:
$250,000 − $21,500 = $228,500

While this still provides meaningful support, the reduction can significantly impact your family’s financial plans.

The Biggest Risk: How an Unpaid Loan Can Cancel Your Policy

A reduced death benefit is serious, but an even greater risk exists. If loan interest continues to grow and eventually equals or exceeds your policy’s cash value, the policy can no longer sustain itself.

When this happens, the insurer may terminate the policy in what is called a policy lapse. The coverage ends completely because the internal debt has become too large for the policy to support.

If a policy lapses, the death benefit disappears entirely, leaving beneficiaries with nothing. This is why managing policy loans is critical. Paying interest regularly or reducing the loan balance helps protect the policy from lapsing.

Loan vs. Withdrawal: Which Makes Sense for You?

The right choice depends on whether your financial need is temporary or permanent.

Choose a Policy Loan if:

• Your need is temporary
• You plan to repay the loan
• You want to preserve the full death benefit
• You can manage interest payments

Choose a Withdrawal if:

• Your need is permanent
• You are comfortable with a smaller death benefit
• You want to avoid interest and repayment obligations

Withdrawals are often tax-free up to the amount you have paid in premiums, but they permanently reduce coverage, so this decision should be made carefully.

Using Your Policy’s Cash Value Wisely

Accessing your policy’s cash value can be a powerful financial tool, but it is not free money. Every loan or withdrawal affects the future protection your policy provides.

To plan wisely:

• Review your latest policy statement to know your cash value
• Ask your agent about loan interest rates and repayment options
• Understand how withdrawals affect your long-term coverage
• Consider informing your beneficiaries if you take funds from the policy

Your life insurance is a lasting promise to your loved ones. By managing loans and withdrawals carefully, you protect that promise and ensure your policy continues to provide the security and peace of mind it was meant to deliver.

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