Life insurance policies are designed to provide financial support to your loved ones upon your death. Although they have been around for many years in South Africa, it is a lesser-known fact that these policies can be used for protection when facing financial distress.
In this article, we’ll discuss popular types of life insurance policies, whether you can borrow money from these policies and the pros and cons of borrowing money from your life insurance.
If you’re considering borrowing money from your life insurance policy or simply want to learn more about life insurance policies, keep reading!
Different Types of Life Insurance Policies
There are many types of life cover policies offered in South Africa, the most popular being term life, whole life, endowment, unit trust-based, and funeral policies.
- Term Life Policies: This basic life policy can be taken out for a flexible term (typically between 5 and 30 years). This policy pays out to beneficiaries if the insured party dies within the policy’s term.
- Whole Life Policies: This policy is permanent and offers coverage for the entire lifetime of the insured party. Some companies provide cash value components that can be used to withdraw from the policy.
- Endowment Policies: This savings-based policy pays out a lump of money at the end of the specified term or upon the insured party’s death, whichever comes first.
- Unit Trust-Based Policies: Unit trust policies are linked to an individual’s investment portfolio. The policy’s value is determined by the investment portfolio’s performance. This policy can potentially yield higher returns than other life insurance policies.
- Funeral Policies: This policy usually has lower premiums as it only covers funeral and other related activities expenses. This policy cannot be used to borrow money from the bank or as collateral for a bond.
These five policies are merely the most popular, although various other options are available, such as disability cover, hospital plans, and critical illness cover. Life insurance policies are complex and over varying benefits and coverage.
Discussing all your options with your financial adviser before deciding on a policy is always best.
Life Insurance Policy Loans
In South Africa, borrowing money from your life insurance policy is not very common, although it is possible. There are three main ways to take a loan from your life insurance. However, not all banks and insurance companies accept these loans.
Withdrawal From Life Insurance
Certain insurance companies allow you to withdraw money from the amount saved within the policy. These companies’ withdrawals are structured as loans but are actually only withdrawals from your life cover policy.
Typically, the insurance company allows the owner of the policy to withdraw an amount equal to that of the current cash value of the policy. The cash value is roughly defined as the accumulated value of all the premiums paid to date.
However, different companies might have different definitions of ‘cash value’. They may also have varying terms and conditions for policy withdrawals, so reviewing your policy’s specific terms before making any decisions is important.
Life Policy Cash Value as Security
This method involves using the cash value of your life policy as security for a bank loan. However, the cash value is critical when determining if the life policy is sufficient collateral. In most cases, the cash value of a life policy would not be sufficient enough to secure a loan from a bank.
This is especially true if your policy does not have a high cash value yet. The bank might claim that it would not be enough collateral to repay the loan. In South Africa, banks usually consider your overall credit score when considering your ability to repay a loan. A low credit score might result in low-interest rates or complete loan denial.
An important note to remember is that not all life insurance policies have a cash value component. If you have a temporary term policy, you typically do not have this component – unless otherwise stated in your contract.
Conceding Your Life Insurance Policy
This is similar to conceding your cash value as collateral. However, when you cede the policy to the bank, you temporarily transfer the ownership of the policy to the bank. Once your debt is paid off, the bank returns the policy to you.
In this case, the bank is recognizing your life policy as an asset and taking it as “security” in case you may not be able to repay the loan.
Pros and Cons of Borrowing Cash From Your Life Insurance
Lending money from your insurance might seem like a good idea, but there are some associated risks. Here are the pros and cons you should consider:
Pros:
- Access to ‘quick’ cash: One of the biggest advantages of borrowing money from your life cover policy is that you have quick and easy access to some cash. Traditional loans tend to take weeks to process and can be unhelpful if you need money as soon as possible.
- No credit check required: Generally, borrowing money from your own policy does not require a personal credit check. If you have a low credit score, you might still be able to get some cash. Remember that banks do a credit check, so if you plan on using your policy as collateral, you will be subject to a credit check.
- No repayment schedule: You can pay back the loan to your insurance company on your own terms (usually). This is a great option if you’re unsure when you’ll be able to pay back the loan.
Cons:
- Reduced Death Benefits: When you borrow your policy’s cash value, it significantly reduces the death benefits that your loved ones will receive in the event of your death. If you do not repay the amount that you borrowed before your death, your loved ones will be left with little to no payout.
- Tax implications: Depending on your insurer and your policy contract, tax implications might be charged when borrowing money from the policy. You might be required to pay income tax on top of the monthly premiums. Also, if you surrender your policy to the bank, you might be responsible for taxes on the gains you’ve earned.
- Interest accumulates: Some companies allow you to withdraw or borrow money from your life policy, but you are subjected to higher interest rates.
Final Thoughts
Overall, borrowing money from your life insurance is possible, but it’s vital to understand your policy terms and conditions. It might seem like a quick and easy way to get cash, but there are significant downsides to reducing your policy’s cash value.
We recommend speaking to a financial advisor to discuss the pros and cons, as well as alternatives fit for your specific financial situation.
