Leveraging a Life Insurance Policy

Leveraging a Life Insurance Policy

Life insurance policies with a cash value component, such as universal life and permanent life policies, can be flexible financial planning tools – for both individuals and businesses. One way to access the cash value during the lifetime of the insured is by taking out a loan from a financial institution, using the policy as collateral. This is called “leveraging” a life insurance policy.

The primary advantage of this approach is that under current tax laws, the loan proceeds can be received tax free. In addition, loan interest may be deductible if the loan proceeds are used to generate income from business or property.

Whether leveraging is used in a personal or business context, the basic structure is the same. At the time of the loan application, the financial institution will issue a line of credit or a loan to the policy owner, taking the insurance policy as collateral through a collateral assignment.

The maximum amount that can be borrowed is based on a specified percentage of the CSV, usually 50 to 90 per cent depending on the investment options chosen by the policy owner. Interest may be paid annually or added to the loan balance, depending on the lender and the terms of the loan. When a financial institution calculates the loan amount, the calculation is designed to ensure that the loan balance never exceeds the maximum allowable percentage of the CSV before the estimated date of death

Upon the death of the insured, the financial institution has first claim on the proceeds of the policy. After the loan is fully repaid, the excess of the death proceeds, if any, will flow to the designated beneficiary, the policy owner, or the estate if there is no designated beneficiary.