People generally purchase whole life insurance for the death benefit and the cash that accumulates in the policy. Unfortunately, accessing that cash can be more complicated than policyholders expect.
A common approach is to use the policy's cash value as collateral against a loan. Borrowing to unlock value from life insurance is appropriate when your client wants to retain part of the death benefit for the beneficiaries. Any other options for liquidating life insurance — surrendering or selling the policy, for example — leave no death benefit for the policyholder's loved ones.
Many policyholders know they can borrow directly from their insurance carrier. But there are also two other options. Your client can use the whole life policy as collateral for a bank loan. Or your client can obtain a loan through a third-party broker. Read on for a closer look at each of these options, so you can guide your clients to the solution that suits them best.
1. Borrowing Directly from the Insurance Carrier
An insurer-funded loan uses the policy's cash value as collateral. Repayments are technically not required — but not paying at least the interest can put the policy at risk. Unpaid interest is added to the loan balance, which in turn accrues more interest.
Eventually, the interest expense can exceed the policy's dividend income. When that happens, the policyholder will have to pay in more to protect the policy's solvency.
At the same time, the policyholder must stay current on premiums. If the policy lapses for any reason, the policyholder will receive a 1099 for the difference between the loan balance and the cumulative premiums paid. By IRS standards, that amount is income, taxable at the policyholder's ordinary income rate.
If the loan is not repaid when the policyholder dies, the insurer collects the outstanding balance plus accrued interest from the death benefit.
Insurer-funded loans are best for policyholders who are 100% committed to making future premium payments and repaying their loan. Staying current on premiums avoids nasty tax consequences. And repaying the loan balance keeps the death benefit intact.
One challenge policyholders will face is prioritizing loan repayment when the insurer doesn't require it. Policyholders may initially intend to repay the loan, only to change their minds later. That can be problematic if it puts the policy at risk.
2. Borrowing From a Bank
Policyholders may also use their whole life policy as collateral for a bank loan or line of credit. The policyholder will have to complete a loan application — which an insurer wouldn't require. But the bank's interest rate is usually lower than what an insurer would charge.
As part of the loan terms, the policyholder must agree to pay future policy premiums. Not doing so puts the loan in default.
If the loan is still outstanding when the policyholder passes, the bank repays itself from the death benefit. Any remaining amount is paid out to designated beneficiaries.
Lucas Siegel is the founder and chief executive officer of 
