Life insurance glossary
Policy loan
Plain-English definition
Borrowing against the cash value of a permanent life insurance policy while keeping the policy in force.
Access to your cash value without cancelling — but it isn't interest-free, and it isn't always tax-free.
How a policy loan works
A policy loan lets you borrow money using the cash value of a permanent policy as security, while the policy stays in force. Because you are borrowing against your own accumulated value, approval does not depend on a credit check the way a bank loan would, and the money can usually be accessed relatively quickly.
The loan accrues interest set by the insurer. You are not strictly required to repay on a fixed schedule the way you would a personal loan, but interest keeps accumulating, and any outstanding balance plus interest is deducted from the death benefit if you die before repaying. Left unmanaged, a growing loan can erode the very protection you bought the policy for.
The tax trap people miss
It is a myth that policy loans are always tax-free. In certain circumstances a policy loan can trigger a taxable policy gain, depending on how much you borrow relative to the policy's adjusted cost basis. The interaction between loans, withdrawals, and the adjusted cost basis is one of the more technical corners of life insurance taxation.
There is also a compounding risk: if the loan and its interest grow large enough to exceed the cash value, the policy can lapse — and a lapse with a large outstanding loan can crystallize a tax bill at the worst possible time. Before borrowing, confirm the tax treatment and the lapse risk with a licensed advisor rather than assuming the loan is free money.