Borrow Against Whole Life Insurance: Loans, Withdrawals, Taxes and Lapse Risk

You can borrow against whole life insurance once your policy has built cash value, and you don’t need a credit check or a loan application in the usual sense. The money comes from the insurer, with your policy as collateral. But a loan is only one of three ways to get cash out. You can also withdraw, or you can surrender the policy. Each one is taxed differently, and each one affects the death benefit differently. This guide compares all three, shows how interest can make a policy lapse, and explains the modified endowment contract (MEC) tax trap.

This page is general information, not tax or legal advice. For your own numbers, ask your insurer for an in-force illustration and talk with a tax professional.

How do you borrow against whole life insurance?

When you borrow against whole life insurance, you don’t withdraw your own cash value. The insurer lends you money and holds your cash value as security. Your cash value stays in the policy, and the loan balance is tracked next to it. That is why the loan is often called a policy loan or a whole life insurance loan.

State law protects this right. In Massachusetts, M.G.L. c. 175, § 142 says that once premiums have been paid for at least three full years, the owner can borrow up to the policy’s loan value, secured only by the policy. The insurer deducts any existing loan and accrued interest from that loan value. Your contract may describe its own timing, so read the loan section.

Massachusetts also lets an insurer delay a cash loan for up to six months from your written request, under c. 175, § 132. Loans used to pay premiums on the policy are excluded from that delay. In practice, most owners simply call the insurer or use a loan form. Still, don’t count on the money arriving the same week if timing is critical.

The steps to borrow against whole life insurance are usually short:

1. Check your latest annual statement for the current loan value and any existing loan.
2. Ask the insurer for its loan form or online request, plus the current loan interest rate.
3. Choose the amount. Borrowing less than the maximum leaves a cushion for interest.
4. Choose how you want to be paid, usually by check or direct deposit.
5. Keep the insurer’s confirmation, which should show the starting interest rate.

Can you borrow against term life insurance? No. Term coverage has no cash value, so there is nothing to lend against. That is one of the main differences explained in our term vs. whole life guide.

Life insurance loan vs withdrawal vs surrender

The table below compares the three ways to get money out of a whole life policy that is not a MEC. MEC rules are covered further down. The tax column is based on Internal Revenue Code § 72(e) and IRS Publication 525 (2025 edition).

The life insurance loan vs withdrawal choice often comes down to whether you plan to pay the money back. A loan keeps your full coverage as long as you repay it. A withdrawal is simpler, with no interest, but the coverage it removes does not come back. MetLife’s whole life FAQ (a carrier source) says that withdrawing dividends or the cash value of paid-up additional insurance will reduce the death benefit.

Whole life insurance loan interest rates

Every whole life insurance loan charges interest, and the policy must say how the rate is set. Most states follow the NAIC Model Policy Loan Interest Rate Bill, adopted in 1981. It gives insurers two choices:

• A fixed maximum of no more than 8% a year.
• An adjustable maximum that can’t exceed the higher of two figures: Moody’s Corporate Bond Yield Average for the month ending two months before the rate is set, or the rate used to compute the policy’s cash values plus 1%.

Massachusetts writes the same two options into § 142. For context, the NAIC’s published Moody’s average was 6.25% for September 2026 and 6.09% for August 2026. That index is a cap on adjustable rates, not the rate your insurer charges. The actual cost to borrow against whole life insurance is in your contract or your annual statement.

If your policy uses an adjustable rate, the model law adds guardrails. The rate must be reviewed at least once every 12 months, but not more often than once every three months. The insurer may raise it when the formula supports an increase of half a percent or more. It must lower it when the formula supports a decrease of half a percent or more.

The insurer must tell you the starting rate when you take a cash loan and give you reasonable advance notice of any increase. The model also says no policy can end in a policy year solely because the loan rate changed during that year.

Some carriers also change the dividends they credit on borrowed cash value. Ask your insurer whether it does this before you borrow against whole life insurance, because it changes the true cost of the loan.

How a loan can make your policy lapse

Interest you don’t pay doesn’t disappear. MetLife’s FAQ says unpaid loan interest is added to the loan principal and incurs additional interest charges. Over time, the loan can grow faster than your cash value. When the loan plus interest passes the value it is secured by, the policy can end. MetLife calls this loan termination.

State law gives you a short warning. Under Massachusetts § 142, failure to repay a loan or interest doesn’t void the policy until total indebtedness equals or exceeds the loan value, and then not until 30 days after the insurer mails notice to your last known address. Other states have their own rules, so check your contract.

A second trap is the automatic premium loan. MetLife describes it as a provision that takes a loan against cash value to pay a premium that wasn’t paid within the grace period. That keeps coverage in force, but each missed premium quietly adds to the loan. If you have this feature, read every annual statement.

If a warning letter arrives, act inside the notice period. You can usually pay enough of the loan or interest to bring the balance back below the limit. If the policy does end, Massachusetts § 132 lets an owner apply to reinstate within three years of default, but only with proof of insurability the insurer accepts and payment of overdue premiums and debts with interest. Reinstatement isn’t available if the cash surrender value has been paid out. In other words, a lapse is hard to undo once your health has changed.

The safest habit when you borrow against whole life insurance is simple: pay at least the yearly interest. MetLife encourages owners to do this at a minimum. Paying the interest keeps the balance flat, and paying down principal rebuilds your death benefit.

Hypothetical example: when an unpaid loan catches up

Hypothetical example. Linda, 60, owns a paid-up whole life policy with $45,000 of cash value. She has paid $38,000 in total premiums, and that is her cost basis. She takes a $30,000 loan at a fixed 8% rate and pays nothing back. To keep the math simple, assume her cash value grows 3% a year and interest compounds yearly.

In year 9 the loan passes the cash value. After the required notice, the policy ends unless Linda pays enough to bring the loan back under the limit. Her family loses the death benefit entirely.

Now the tax bill. MetLife’s FAQ says that when a policy with a loan terminates, the loan plus unpaid interest is treated as received by the owner, and anything above cost basis is taxable. Linda is treated as receiving $59,970.14. Subtract her $38,000 basis, and $21,970.14 is taxable income, even though she receives no cash that year.

The fix was cheap by comparison. Paying the interest each year, 8% x $30,000 = $2,400, would have kept her loan at $30,000 and the gap with her cash value would have widened over time. This example uses made-up figures. Your contract’s guaranteed values, dividends and loan rate will differ.

How taxes work when you borrow against whole life insurance

For a policy that is not a MEC, the tax code treats money taken out during life gently. Under IRC § 72(e)(5), amounts received under a life insurance contract are taxable only to the extent they exceed your investment in the contract. Your basis comes out first. That is why a modest withdrawal is often tax-free.

Your investment in the contract is defined in § 72(e)(6) as premiums paid, minus amounts you already received tax-free. IRS Publication 525 (for 2025 returns) puts it plainly: your cost is generally the total premiums you paid, less refunded premiums, rebates, dividends, or unrepaid loans that weren’t included in income.

A whole life insurance loan from a non-MEC policy is generally not treated as income while the policy stays in force. The tax arrives if the policy lapses or you surrender it with a loan outstanding, as the example above showed.

If you cash out whole life insurance by surrendering it, Publication 525 says you must include in income any proceeds that are more than the cost of the policy. You should receive Form 1099-R showing the total proceeds and the taxable part. The death benefit is a different matter. Our guide Is life insurance taxable? covers that side.

The MEC trap: IRC § 7702A and § 72(e)(10)

Everything above changes if your policy is a modified endowment contract. Under IRC § 7702A, a contract entered into on or after June 21, 1988 becomes a MEC if it fails the 7-pay test. It fails when the amount paid in during the first seven contract years is more than the sum of the net level premiums that would have paid up the policy in seven annual payments.

Three details catch people out:

• Benefit reductions. If benefits are reduced in the first seven years, the test is applied as if the policy had been issued at the lower level. That can turn a policy into a MEC after the fact.
• Material changes. A material change in benefits or terms makes the policy count as a new contract on the date of the change, which restarts the test.
• The two-year look-back. Any distribution made within two years before the policy fails the test is treated as made in anticipation of that failure.

Under § 72(e)(10), a MEC is taxed income-first, and loans, including pledging the policy, are treated as distributions. So a MEC loan can be taxable even though you plan to repay it.

On top of that, § 72(v) adds a 10% tax on the taxable part. It does not apply to payments made on or after age 59½, payments due to disability, or a series of substantially equal periodic payments over your life or joint lives.

Single premium policies almost always fail the test. Our single premium whole life guide works through that case. If you’re unsure about your policy, ask the insurer in writing whether it is a MEC before you borrow against whole life insurance.

Should you cash out whole life insurance or borrow?

To cash out whole life insurance means surrendering it. You get the cash surrender value, minus any loan, and the coverage ends for good. That makes sense in some cases, and is a costly mistake in others. Our whole life insurance guide explains why values in the first five to ten years can be far below what you paid.

Choosing to borrow against whole life insurance usually fits better when:

• You still need the death benefit, for a spouse, a mortgage or final expenses.
• The cash need is short-term and you can pay at least the interest.
• Your health has changed, so replacing the coverage would be expensive or impossible.

Cashing out may fit better when:

• Nobody depends on the death benefit any more.
• You can’t afford the premiums or the loan interest.
• A large loan already makes a lapse likely, and a planned surrender is cleaner.

There is also a middle path. Massachusetts § 132 requires the policy to include a table of loan values, cash surrender values and paid-up benefits for the early policy years. A reduced paid-up option, if your contract has one, stops premiums and keeps a smaller policy in force. Ask for those numbers before deciding.

Checklist before you take a whole life insurance loan

1. Get an in-force illustration showing the loan, interest and projected values for at least the next ten years.
2. Find your loan rate and whether it is fixed or adjustable. If adjustable, ask how often it resets.
3. Ask about dividends on borrowed cash value, if your policy pays dividends.
4. Confirm MEC status in writing.
5. Check for an automatic premium loan and any existing loan balance.
6. Decide how you will pay the interest, and set a reminder for the policy anniversary.
7. Tell your beneficiaries that the death benefit is now lower.

If you also own term coverage that is nearing its end, our guide to what happens when term life insurance ends explains your options, including converting it to a policy that builds cash value.

Borrow against whole life insurance: frequently asked questions

How soon can I borrow against whole life insurance?

Once the policy has loan value. Massachusetts law guarantees the loan right after premiums have been paid for at least three full years. Your contract’s loan section and annual statement show your current loan value.

Do I have to repay a whole life insurance loan?

There is usually no fixed repayment schedule. But unpaid interest is added to the loan, any balance is deducted from the death benefit, and the policy can lapse if the loan grows past the loan value.

Is a life insurance loan taxable?

From a non-MEC policy, a loan is generally not income while the policy stays in force. From a MEC, loans are taxed income-first and may carry a 10% additional tax before age 59½. This is not tax advice.

What happens to the loan when I die?

MetLife’s FAQ says the loan plus accrued unpaid interest is deducted from the death benefit. Your beneficiaries get the rest.

Which is better: a life insurance loan vs withdrawal?

A withdrawal has no interest but permanently lowers coverage. A loan keeps coverage if you repay it, but charges interest and adds lapse risk. If you won’t repay, a small withdrawal can be the cleaner choice.

Can I borrow against whole life insurance to pay my premiums?

Often, yes. The NAIC model law counts a premium loan, made to pay premiums that weren’t paid when due, as a policy loan. Some policies do this automatically through an automatic premium loan. It keeps coverage in force but adds to the loan balance and its interest.

Can I cash out whole life insurance without paying taxes?

Only if what you receive is not more than your cost in the policy. IRS Publication 525 says proceeds above your cost are taxable, and the insurer reports them on Form 1099-R.

Talk to a licensed agent before you borrow

Before you borrow against whole life insurance or surrender a policy, it helps to see the numbers side by side. Octans Insurance is an independent life and health insurance agency based in Massachusetts. Our licensed agents can review your situation and, if new coverage makes sense, compare options across the 120+ carriers we work with. There is no fee for our help. Call (617) 935-9220. For tax questions, also check with a CPA or tax advisor.

Keep Reading: Related Guides

• Whole life insurance
• Is life insurance taxable?
• Single premium whole life insurance
• Term vs whole life insurance
• How to convert term life insurance to whole life
• 1035 exchange life insurance
• Life insurance grace period and lapse

Important: Octans Insurance agents are licensed in the states in which they operate. Coverage availability and rates may vary by state. Premium examples, when provided, are illustrative samples from published sources, not quotes. Final rates are determined by the insurance carrier based on underwriting and applicable policy criteria. Policy terms, exclusions, limitations, riders, and availability vary by carrier and state.

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