How Does a Policy Loan Work?
When you take a policy loan, most companies will immediately charge you the cost of interest for the rest of your policy year. In other words, if you are 3 months into a new policy year and take a loan, you will be charged up front for nine months of interest. If you decided to pay back some or all of the loan before the end of the year, the company will reimburse the cost of the interest that they had previously deducted. You can choose to have the policy loan be net or gross of this interest deduction.
If you are using the banking concept we’ve discussed and have scheduled a payback schedule, each payment won’t only result in a reduction of your loan, but will also earn you back the interest that had been previously deducted from your policy. Remember, this has no impact either way on the earnings that your whole life policy attains (through increases in cash value or dividends), but is accounted for separately as a loan.
Each policy anniversary the company will again charge you for the upcoming year’s interest. It sometimes seems strange that they charge for interest many months in advance, but they do this so that they can absolutely guarantee that your policy can fully collateralize the loan. This is in turn why they are able to offer such amazingly good loan terms (very low interest rate, absolutely flexible repayment plan, etc.). And because they pay you back the interest they had previously charged you if you repay the loan, it makes absolutely no financial difference to you either way.
In conclusion, while we usually like the policy loan in most situations to access money from your whole life policy, sometimes a withdrawal makes more sense, so we should work together to determine what is right based upon all your circumstances. Also, we do foresee a time in the not too distant future where it might make sense to use withdrawals to pay off policy loans, but we can’t know for sure when or even if that will happen and so will make that determination when it does.
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