A life insurance policy includes a provision that allows the policyowner to borrow against the policy's cash value. Which of the following statements is TRUE regarding this provision?
- AThe loan interest rate is usually fixed for the life of the loan.
- BThe insurer can refuse a policy loan if the policyowner's credit score is too low.
- CIf the insured dies with an outstanding loan, the death benefit will be reduced by the loan amount plus interest.
- DPolicy loans are taxable income to the policyowner when taken.
Show answer & explanationAnswer & explanation
Correct answer: C. If the insured dies with an outstanding loan, the death benefit will be reduced by the loan amount plus interest.
Policy loans are not considered taxable income when taken, as they are borrowing against your own money. The insurer cannot refuse a loan as it's a contractual right. Loan interest rates can be fixed or variable. The most important consequence of an outstanding loan at death is the reduction of the death benefit by the loan amount plus any accrued interest.
Why the other options are wrong
- A. Loan interest rates can be fixed or variable, depending on the policy terms.
- B. Policy loans are a contractual right and cannot be refused by the insurer based on credit score.
- D. Policy loans are generally not taxable income; they are considered a loan against the policy's value.
Life Insurance Policy Loan
A feature of cash value life insurance policies that allows the policyowner to borrow money from the insurer, using the policy's cash value as collateral.
- Not taxable income when taken
- Contractual right, cannot be refused
- Interest is charged
- Outstanding loan reduces death benefit
- Policy can lapse if loan + interest exceeds cash value
Memory trick: Policy loans are 'your money' with 'strings attached' (interest, death benefit reduction).