Life insurance borrowing is one of the most misunderstood features in permanent life insurance. Many high-net-worth individuals and their advisors believe policy loans are “cheap” or even “zero-cost.” In reality, the true cost of life insurance borrowing is often higher than people calculate — and getting it wrong can put your policy at serious risk.
If you are contemplating a policy loan, understanding the real cost of life insurance borrowing is essential for smart financial planning.
My name is Scott Witt, and I am an Actuary and a Consumer Advocate. If you would like more tips on how high-net-worth individuals with $100,000 or more invested in cash value life insurance or annuities can maximize the value of their policies, join my newsletter.
Why the True Cost of Life Insurance Borrowing Matters
Most people compare the policy loan rate directly to a bank loan or home equity line of credit (HELOC) and assume the life insurance option is better. This faulty math leads to potentially dangerous outcomes:
- Over-borrowing from the policy
- Increased risk of a “surrender squeeze,” policy lapse, or unexpected taxes
- Underestimating the appeal of paying back policy loans
Life insurance borrowing only makes sense when you fully understand the net cost — not the advertised rate.
Direct Recognition vs Non-Direct Recognition: The Key to Life Insurance Borrowing Costs
The true cost of life insurance borrowing depends entirely on whether your policy uses Direct Recognition (DR) or Non-Direct Recognition (non-DR).
- Direct Recognition (DR): The insurance company sets the crediting rate on the borrowed portion of your cash value in relation to the stated loan rate, usually with a small spread. The loan rate is usually fixed but is irrelevant to the true cost of borrowing.
- Non-Direct Recognition (non-DR): Borrowed and unborrowed cash value earn the same crediting rate. The loan rate is separate and usually variable, often tied to a reference rate.
Direct Recognition Example – Life Insurance Borrowing
- Loan interest rate: 8.0%
- Crediting rate on borrowed cash value: 7.8% (0.2% spread)
- Crediting rate on unborrowed cash value: 6.0%
Common mistakes people make with life insurance borrowing:
- Thinking it only costs 0.2% (the spread)
- Thinking it costs the full 8.0%
True cost of life insurance borrowing = 6.2%
Calculation: The borrowed cash value earns an extra 1.8% compared to unborrowed funds (7.8% vs 6.0%). True net cost = 8.0% loan rate – 1.8% extra crediting = 6.2%
(Identically, you can also calculate the true cost of borrowing on a DR policy as the crediting rate plus the spread. In this case, that would be 6.0% + 0.2%, or 6.2%.)
Even “zero-spread” loans are not zero-cost. The true cost equals the crediting rate on unborrowed cash value.
Non-Direct Recognition Example – Life Insurance Borrowing
- Variable loan rate: 5.0%
- Crediting rate (borrowed and unborrowed): 6.0%
True cost of life insurance borrowing = 5.0% (simply the loan rate).
Many people wrongly believe this is “free” borrowing or even that they’re earning 1%. That misunderstanding can lead to erroneous conclusions regarding borrowing.
Is Life Insurance Borrowing Cheaper Than a Bank Loan or HELOC?
It depends on the true cost (not the sticker rate), your tax situation, and how the policy is managed. Once you know the real number, paying off an existing policy loan can become one of the best low-risk financial moves available — often beating conservative bonds with zero market volatility.
Do You Need a Professional Review of Your Life Insurance Borrowing Strategy?
As an independent actuary and consumer advocate (not an insurance agent), I help high-net-worth clients and their advisors analyze the true economics of their policies.
I provide unbiased answers on:
- The real cost of life insurance borrowing in your specific policies
- Which policies to keep, replace, modify, or surrender
- Safe borrowing limits to avoid lapsation
- How to maximize long-term cash value growth
- Optimal strategies for retirement income and estate planning
Frequently Asked Questions About Life Insurance Borrowing
What is the true cost of life insurance borrowing? It is usually the loan rate plus or minus the marginal spread earned on the borrowed cash value (for Direct Recognition policies) or simply the loan rate for non-DR policies. It is not the tiny spread or “zero” that some agents claim.
Is life insurance borrowing a good idea? It may be a good source of income/liquidity for some — when used responsibly and with full awareness of the true net cost. Poor understanding often leads to over-borrowing and policy problems.
How does Direct Recognition affect life insurance borrowing? It adjusts the effective cost by giving borrowed cash value a crediting rate that is set in reference to the loan rate and independent from the crediting rate on unborrowed funds. Appealingly, companies that use Direct Recognition do not have the crediting rate on unborrowed funds affected by borrowing activity, whereas Non-DR companies always have some cross-subsidization in one direction or another depending on the relationship of the variable loan rate and the crediting rate used on all borrowed and unborrowed funds.
Can you borrow from life insurance without paying interest? No. There is always a cost, even in non-Direct Recognition or “zero-spread” designs.
Does life insurance borrowing affect the death benefit? Yes — outstanding loans reduce the death benefit paid to your beneficiaries.
Ready for a second opinion?
I am an Actuary and a Consumer Advocate (not an insurance agent) who helps high-net-worth individuals with $100,000 or more invested in cash value life insurance or annuities to maximize the value of their policies.
High-net-worth individuals and their advisors hire me to help:
- Analyze existing life insurance policies and annuities to provide customized recommendations for optimizing value
- Consider impact of objectives, longevity, tax considerations, and opportunity cost on life insurance and annuity decisions
- Access/design life insurance policies and annuities that eliminate (or reduce) agent compensation and maximize policy value
- Provide an unbiased perspective free from any conflicts of interest
- Avoid making critical mistakes and provide peace of mind
- Provide a qualified appraisal on life insurance policies
- Assess whether to buy term and invest the difference or buy a cash value policy
To learn more, please contact me.
Disclaimer
Witt Actuarial Services does not guarantee any specific level of performance, the success of any strategy that Witt Actuarial Services may use, or the success of any program. Information contained herein may become out of date; Witt Actuarial Services is under no obligation to advise users of subsequent changes to statements or information contained herein. There is no guarantee that the information contained herein is accurate. This information is general in nature; specific advice applicable to your current situation is only available through an engagement. Any perceived similarity with persons living or deceased is entirely coincidental.