Why You Must Avoid Borrowing from Your Life Insurance Policy

A life insurance plan is an ideal way to secure your family's financial needs. It is designed exclusively for providing a sum assured to the nominee in case of your unexpected demise. However, some insurance products offer an easy availability for loans from the cash value accumulated through the premiums paid in the life insurance policy. Though it satisfies an emergency need and provides benefits over a traditional loan process from a bank, it is certainly a bad idea.

Here, we will discuss why you must avoid borrowing from a life insurance plan. Before we start, we should understand how the loan process in the life insurance policy works.

What does a life insurance policy loan essentially mean?

Loans from policies are primarily based on the cash value of the life insurance policy. In such a loan process, you are actually borrowing from your own money. It can be considered as an advance amount that your loved ones get as a death benefit. 

You generally prefer a policy loan because it differs from a traditional loan availed of from a bank. You don't have to go through the normal lengthy process of application. Also, it is not mandatory to repay the loan. You can take your own time and schedule the repayment as you desire.

How does borrowing from a life insurance policy work?

When you purchase a life insurance policy, you will accumulate a cash value with regular premium payments through the policy term. Each insurer will have a certain limit set for the cash value to become eligible for a loan. When the limit is attained, the loan requirement is accepted. 

The cash value will be considered as the collateral for the policy loan. The loan amount available is a certain percentage of the cash value. The interest charged is based on the cash value, term and the loan amount availed. Though the procedure does not mandate you to pay back the loan, it is not a good option to borrow from an insurance policy. 

Why should you avoid borrowing from life insurance policies?

Though the policy loan offers various benefits, it has a real flipside. Let us discuss and understand them in a little detail.

 

1. Death benefit affected
   
   

   The sole purpose of buying a life insurance policy is to provide a lump sum benefit as a sum assured to your loved ones in case of an unfortunate event If you avail of a loan from such a policy, it will affect the cash value accumulated over time. By any chance, if you refrain from paying back the loan, the insurer will reduce the amount from the cash value or deduct it from the death benefit when it is paid out.
   
   Also, if you had opted for the critical illness rider^# benefit, you are eligible for getting the insured amount for your hospitalisation charges. However, if the cash value has diminished, the insurer might refrain from accepting the treatment expenses. 

 

2. Policy lapse
   
   If you plan to take too much money from the life insurance plan, the cash value will run out of money. If the sum of loan interest and the unpaid loan amount exceeds the cash value, the policy will automatically lapse. The pain taken to pay the premium amount regularly for a cause will certainly go in vain. You can pay the loan amount and the interest additionally out of your pocket. However, it will take a lot of time for the policy to return to its original form. 
   

 

3. Taxation issues
   
   The life insurance policies provide tax benefits. However, suppose you are availing of a loan and staying away from repaying it. In that case, the cash value diminishes totally and the policy lapses. The gains taken as a loan become taxable going further. The tax* amount is relatively higher than you actually expect. Insurance will become a financial burden rather than resolving your crisis during an uncertain event. 
   

 

4. Paying premium does not compensate
   
   If the policy is about to lapse, and you try to maintain it by making the regular premium amounts, it may not suffice to afford the cash value accumulated earlier. If you don't ensure to pay the interest or the loan back, the interest accrued will increase the loan balance above the policy's cash value. In that case, the policy will lapse, or you have to surrender it.
   

Life insurance plans provide various features. TATA AIA offers a wide range of life insurance plans that cater to varied needs and requirements. Tata AIA online premium calculation, payment and the add–on riders^# are unique and extremely beneficial. It is suitable advised to compare different plans and find the one that best suits your unique requirements.

Conclusion

A life insurance plan is designated to protect your family's financial status. It will serve as the only lifeline for reducing the financial burden and accomplishing long-term financial commitments.

When you are borrowing against an insurance plan, it will reduce the death benefit, lead to a policy lapse in the worst case, accrue a hefty tax* burden and certainly becomes difficult to compensate by regularly paying the premium amount.

As a general and advised practice, it is better to avoid borrowing from your life insurance plan. Look out for alternative plans during an emergency or make an effective financial plan early in life to stand by! 

L&C/Advt/2021/Oct/1751