life insurance

Dear Liz: My wife and I live on her pension, my Social Security, and enough dividends from our blue-chip stocks to cover our daily living expenses. But at our age (80), we would like to spend a little more in order to travel. We will have to borrow the money for that. I see that I can take a loan against our life insurance, at a very low rate of around 2%. The alternative is to take a margin loan, which currently costs 8.75%. It appears to me I should be borrowing against life insurance (we’re thinking of a loan of $10,000, against the life insurance face value of $900,000), where repayment would be assured from proceeds at the time of death (if not sooner, depending on our regular cash flow). Are there pitfalls to using life insurance loans?

Answer: There are pitfalls to any kind of loan, so you’re smart to want to educate yourself before you borrow.

Life insurance loans allow you to borrow against the cash value that’s accumulated in a permanent life insurance policy, such as a whole or universal life policy. The cash value is the savings component of your policy that’s typically built up over time. It’s not the same as the face value, which is how much the beneficiary is supposed to be paid when you die.

You typically have a lot of flexibility over how you pay the money back. If the policy allows, you can even opt to make no payments and have the loan plus interest deducted from the death benefit.

The big risk, besides leaving a beneficiary short of funds, is that the debt could grow to the point where it exceeds the policy’s cash value. At that point, the policy can lapse and potentially trigger taxes on the borrowed money.

You may have other options to fund your travel, such as selling some stocks, borrowing against your home equity or even taking out a reverse mortgage. Each option has advantages and pitfalls, so you’d be wise to discuss your situation with a fee-only financial planner for personalized advice.