Are Loans from a Life Insurance Policy Taxable?

Taxability of Policy Loans

Borrowing money from a life insurance policy does not create taxable income. The loan is a loan, not a distribution, so the IRS does not treat it as income while it remains outstanding.

When Tax Issues Arise

Tax consequences emerge only if the loan is not repaid. If the policy lapses or the loan balance exceeds the policy's cash value, the excess is treated as a taxable distribution. The amount subject to tax is the loan balance minus the policy's cost basis.

Key Points to Track

• Loan amount is not income while the policy stays active.
• Repayment reduces the loan balance; interest is not deductible for personal loans.
• If the policy dies or lapses with an outstanding loan, the excess becomes taxable income.
• State tax rules may differ; consult a tax professional for specifics.