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Expert Advice: Borrowing from life insurance

Do you have a financial question that's keeping you up at night? Ever wished you could get a second, or third, opinion on what to do with your money? Here's your chance: Bankrate.ca hosts a monthly feature whereby you submit [canadianeditor@bankrate.com] a question, and we ask industry experts to weigh in. The topics are up to you—you ask the questions, and we'll get the answers.

Here's this month's question: Is it true that I can borrow money from my life insurance? What's involved and is it a good idea?

You can borrow against life insurance, but it first depends on the type of policy. Term insurance covers you for a specific number of years; it doesn't, however, accumulate cash value, so there's no savings or loan component.

Permanent Insurance, which includes whole life and universal life, provides life-long coverage and offers certain "living benefits," one being it's an actual asset and increases in value over time. While premiums tend to be higher, you build equity that you can cash in or borrow (usually to a maximum of 90 per cent of the cash value) should the need arise.

How you spend it is up to you and unlike a bank, your life insurance company cannot decline your loan request due to bad credit.

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It's important to note that the death benefit of a policy is reduced proportionally when you take out a loan so unless it's repaid before you die, the amount (plus interest) will be deducted from the total paid out to your beneficiary.

Mark Halpern, certified financial planner, trust & estate practitioner and president of Markham, Ont.-based illnessPROTECTION.com Inc.
"Insurance is often looked at as a grudge purchase, but there are huge benefits as it applies to overall estate and financial planning," says Halpern, who points out that universal life policies are one of the few tax shelters sanctioned by the Canada Revenue Agency. "What a lot of people are not aware of is permanent life insurance allows a Canadian to accumulate money on a tax-free basis, pass it along on a tax-free basis and access that money on a tax-free basis."

With that in mind, he stresses buying insurance as part of a holistic financial plan: "There's a much bigger discussion here to determine how much insurance you really need and how does it fit with cash flow."

People access money for all sorts of reasons -- financial hardship, investment, starting a business, education, medical emergency -- and there are several ways to do it.

Cancel the policy: You receive back the cash value of the account, minus charges. "It's not the most effective way to do it but it's easy to do -- it's your money," says Halpern, who cautions it means losing the insurance protection and by cancelling the policy, shelter time is over: Expect to pay tax on the interest earned.

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-- Posted November 5, 2012
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