Unlocking the Power of Your Life Insurance: Borrowing Against Your Policy

Many Canadians may not realize that their life insurance policy could be a valuable source of liquidity. While most are familiar with term life insurance, which provides coverage for a set period, permanent life insurance—such as whole life or universal life—offers a unique financial advantage: the ability to access its cash value and even borrow against it.

How Does Borrowing Against Life Insurance Work?

Unlike term life insurance, which does not accumulate cash value, permanent life insurance builds cash value over time. This accumulated value can be used as collateral to secure a loan, similar to a home equity line of credit. However, instead of leveraging your home, you are using the cash surrender value of your life insurance policy.

This setup allows you to access capital without tying it to your home or other assets. The loan is typically repayable upon death using the tax-free proceeds from the insurance policy, making it an efficient financial tool.

Corporate Planning and Tax Efficiency

For business owners and incorporated professionals, corporate-owned permanent life insurance can be a powerful tax and estate planning tool. Many professionals accumulate wealth within a corporation but face taxation when withdrawing funds personally. A corporate-owned life insurance policy allows for tax-efficient wealth transfer.

To enhance accessibility, a collateral loan can be arranged against the corporate policy's cash value. This provides liquidity without disrupting corporate tax efficiency. It can be an excellent way to personally access funds while maintaining tax-deferred growth inside the corporation.

Typical candidates for this strategy include business owners or high-income professionals with investment or holding corporations valued at over $1 million, who are not actively withdrawing corporate funds but see their corporate assets growing.

Key Considerations

1. Loan-to-Value Ratio: You can borrow up to 95% of the cash surrender value of a whole life policy (less for universal life policies). If your policy has little or no cash value, borrowing is not an option.

2. Growing Loan Limits: As your policy’s cash value grows, banks may increase your borrowing limit, providing access to more capital over time.

3. Interest Costs: Collateral loan interest rates are typically around prime plus 0.5%.

   
   

Policy Loans vs. Collateral Loans

In addition to collateral loans, another borrowing option is a policy loan, where the insurance company itself lends against the policy. Policy loans allow for capitalized interest, meaning repayments can be deferred until death. However, they come with potential tax consequences if the loan amount exceeds the policy’s adjusted cost basis, leading to taxable income.

Collateral loans, on the other hand, do not trigger immediate taxation since they are not directly withdrawn from the policy. This makes them a preferred choice in many financial strategies, but it is always advisable to consult with a financial professional and accountant before proceeding.

A Strategic Financial Tool

Permanent life insurance is more than just a risk management tool—it is a strategic financial asset that can provide liquidity when needed. Whether for corporate or personal use, borrowing against life insurance can unlock financial opportunities, including real estate investments, business expansion, or supporting family members.

At AJ Wealth Management, we specialize in structuring financial solutions that maximize your assets’ potential while maintaining tax efficiency. If you’re considering leveraging your life insurance for liquidity, let’s discuss how this strategy can work for you.