A Policy Advance and Other Credit

Policy loan vs HELOC and other credit in Canada: which route fits depends on who lends, what secures the debt, what it costs in writing, how it is taxed and what it does to your coverage. A policy loan, which your contract may call a policy advance, is not automatically the cheapest or the fastest route, and a home equity line may cost you less.

Here is what a policy loan is. Your insurer lends you its own money, and the cash value of your specially designed, high-cash-value, participating whole life insurance policy secures the loan. The cash value stays in the policy. You now owe the insurer a debt, and the interest on it is paid to the insurer, the same way interest on any loan leaves your hands. It is not your own money coming back to you, and it is not interest paid to yourself.

Not a policyowner yet? This comparison is not your starting point, and the loan provision is never a reason to buy. First establish a lasting insurance need and what you can afford; then ask for guaranteed and lower dividend scale values at years 1, 3, 5, 10 and 20, and what happens if premiums stop in year 2, 5 or 10 (do I need permanent life insurance?). How the loan works inside the contract is on how a policy loan works.

Before you borrow, can you use money you already have?

The cheapest money is often money you do not have to borrow. Before comparing loans, look at what you can reach without creating a debt. Each has a cost of its own, but none charges interest.

• Savings or an emergency fund. Using it costs you whatever that money would have earned, and it leaves you with a smaller cushion until you rebuild it.
• A TFSA withdrawal. This is not borrowing: the money is yours and comes out without tax. Check the Canada Revenue Agency rules on when the contribution room comes back before you put the money back in, so you do not over contribute.
• Cash dividends from a participating policy. If your insurer declares a dividend, you may be able to change your dividend option and take it in cash. Dividends are not guaranteed, and taking them in cash means they no longer buy paid-up additions inside the policy. A cash dividend is not borrowing, but it may have an income tax consequence under section 148; ask the insurer for its tax reporting and your adjusted cost basis.
• A partial surrender, where your policy allows one. It removes value from the policy for good, reduces the death benefit, and can create taxable income. For a partial surrender, the insurer allocates to the part surrendered only a share of the adjusted cost basis (subsection 148(4)); do not subtract the whole policy's basis from the amount withdrawn. Ask for a written tax estimate first. It is not a loan and cannot be repaid.

Using money you already have has a hidden cost: the time it takes to rebuild it. Decide how you will refill the fund before you touch it.

If none of these fits, or the amount is larger than they can cover, then you are comparing credit. The rest of this guide is about that comparison.

What are the routes usually compared?

If you own a policy with cash value, five routes are usually set side by side. They are not the only ways Canadians borrow (mortgages, car loans and credit cards are left out here), but they are the ones people weigh against a policy loan. Behind each one stands a different lender, and the lender decides the rate, the security and what happens if you stop paying.

A policy loan. The insurer advances its own funds to the policyowner and takes the cash value as security. The cash value is not removed; it stays in the policy and continues to be managed under the contract's terms. What changes is that you now owe the insurer a balance, with interest.

A home equity line of credit. A lender, commonly a chartered bank or a credit union, lends against a charge registered on your home, called a hypothec in Quebec. How much you can borrow depends on the equity in the home and on the lender's assessment of your income and credit. Your home stands behind the debt.

An unsecured line of credit. A lender advances funds against your promise to repay, with no asset pledged. The decision rests on your income and credit history. You can draw, repay and draw again up to the limit, and the minimum payment is set by the agreement, often the interest alone.

A personal loan. Also unsecured, but lent once for a fixed amount and repaid in instalments on dates the agreement sets. The discipline is built in: miss a payment and the lender's collection process starts.

A collateral loan against the policy. A separate lender, not your insurer, provides its own money and takes an assignment of your policy as security. It is often confused with a policy loan, but the lender, the rate, the conditions and the tax result are all different, as set out in a policy loan, a withdrawal and a collateral loan compared.

How do the routes compare side by side?

The table sets each route against the same questions: who lends, what secures it, who sets the rate, whether anyone assesses your credit, whether the terms can change, whether there is a payment schedule, what follows if you stop paying, and what you have at risk. Read it as a list of facts to check against your own documents, not as a scorecard.

If you have been refused credit, or your income is hard to document, the credit assessment column may be the only one you read. For the policy loan, ask the insurer for any fee in writing.

Two cells deserve a second look. "No outside credit assessment" is not the same as "cannot be refused": the policy loan still depends on what the contract and the insurer allow. And "no instalment schedule" is not the same as "no obligation": the debt is real, and it grows if you leave it alone.

Where does a policy loan have real advantages?

On four points it does something the other routes do not. None of them makes it cheaper; each makes it useful in a particular situation.

No outside credit assessment. The cash value secures the loan, so the insurer does not check your credit or verify your income before lending against it. That matters most in the moments that are hardest to plan for: an illness, a business going through a bad year, a year of income a lender will not accept. Those are the moments a lender may refuse an application or reduce a line it already granted. The contract's own limits still apply, and they are set out in the table above.

No instalment schedule. Repayment can usually be made at any time, subject to any minimum the insurer sets, and a partial repayment reduces the interest that runs from that point on. You repay on your own timing, not a lender's. That flexibility is worth something only if you use it, which is why the same point appears again in the next section as a hazard.

Your home is not the security. The policy is. That does not make the loan costless, and it does not mean nothing is at risk: the policy is, and so is the death benefit while a balance is outstanding. What changes is where the risk sits, and for some families keeping the home out of any borrowing matters as much as the rate.

The cash value stays in the policy. It is not withdrawn. Its guaranteed values continue under the contract, though dividends, which are not guaranteed, may be affected. Some insurers state that a loan does not change the dividend credited; others may treat borrowed values differently. Ask yours in writing, and whether that can change. Dividends are declared each year at the discretion of the insurer's board.

Where does a policy loan fall short?

On five points it can lose to the other routes, and each is worth checking before you rely on it.

The rate may be higher. A home equity line is secured by real property with a registered charge behind it, and lenders usually price it as a spread over their prime rate. Your insurer sets the policy loan rate and may change it; it does not fall because a lower offer exists elsewhere. If you already hold a home equity line, it may be the cheaper source of the same money. Compare the written rates you would actually pay.

It may be slower than credit already in place. A policy loan is a request the insurer processes on its own timetable, and joint ownership, corporate ownership, an assignment or an irrevocable beneficiary can add steps. A line of credit that is already open releases money immediately. If speed matters, ask your insurer for its written turnaround on a complete request.

It may not exist yet. In the early years of a policy, most of the premium pays for the cost of putting the coverage in force, and there may be little or no cash value to borrow against. A young policy may offer nothing above the insurer's minimum loan. If you expect to need money in those years, you are comparing a route that is not there yet with routes that are.

It is capped by the cash value. The insurer sizes the loan against the value already in the policy, less anything outstanding and within its stated maximum, not against your need. Other routes are capped too (a home equity line by your equity and the lender's rules, a collateral loan by the lender's view of the policy), but only the policy loan's cap depends entirely on how long you have paid premiums.

No schedule can become no discipline. Nothing sends a missed payment notice. For someone who repays anyway, that is freedom. For someone who does not, it removes the one thing that would otherwise push the balance down, and the debt grows quietly at the insurer's rate. That risk is about behaviour, and no clause in the contract corrects it.

What does each route really cost?

Every route on the table charges interest. Interest on a policy loan runs on the outstanding balance as your policy provides, and it is paid to the insurer like interest to any other lender.

The way the interest is charged also matters. On a policy loan, interest you do not pay may be added to the loan at the time your contract specifies, for example at a policy anniversary, so later interest is charged on a larger balance. Confirm the timing, rate and any minimum repayment with your insurer. No monthly bill reminds you. On a line of credit or a personal loan, a minimum payment arrives every month, so the cost is visible even when it is small.

Illustrative example. Assume you borrow $30,000 and pay no interest for three years, at an assumed rate of 7% a year added to the loan once a year. After year one you owe $32,100; after year two, $34,347; after year three, about $36,751. If you instead paid the interest each year, you would have paid $2,100 a year, $6,300 in all, and still owe $30,000. At an assumed 6% instead, you would pay $1,800 a year, $5,400 over the same three years. The rates are assumptions for the arithmetic, not any insurer's or lender's rate; your own figures come from the insurer's loan statement and your lender's written offer.

So the comparison that counts is between the interest you would actually pay on each route, at the rate each would actually charge you, on the amount you would actually borrow, for the time you would actually take to repay. Worst cases prove nothing: set a policy loan beside high rate unsecured credit and it looks cheap; set it beside an open home equity line and it may look expensive. Compare against the cheapest credit you could actually get. More is on the comparison question, taken seriously.

How is each route taxed in Canada?

This is where a policy loan differs most from the other routes, and where much of what is published online, written for American law, goes wrong. In Canada, a policy loan can create taxable income on the day you take it.

The loan itself can be taxable. Under section 148 of the Income Tax Act, a policy loan is included in the definition of a disposition (paragraph (b) of that definition in subsection 148(9)). Up to your policy's adjusted cost basis, nothing is included in your income. Any part of the loan above that basis is income in the year you receive it, under subsection 148(1). The adjusted cost basis is not simply the premiums you paid: it rises with premiums, falls with the net cost of pure insurance and with each loan, and it usually declines in the later years of a policy. So a loan that would have been untaxed early can be partly taxable later. Quebec residents are also taxed under Quebec's Taxation Act.

Illustrative example. Assume your insurer's statement shows an adjusted cost basis of $25,000 and you take a policy loan of $30,000. The first $25,000 is not included in your income. The remaining $5,000 is included in your income for that year, taxed at your own marginal rate. This assumes the full advance is paid out as cash; if part is applied within the policy, ask the insurer to calculate the proceeds and your adjusted cost basis in writing.

Repaying can give some of it back. If part of a loan was included in your income, repaying it later generally gives you a deduction under paragraph 60(s) of the Income Tax Act, up to the amount that was included. The details are on when a policy loan becomes taxable and a policy loan higher than the adjusted cost basis.

A collateral loan is different. Paragraph (f) of the same definition excludes an assignment of a policy as security for a debt, other than a policy loan. So when a lender lends against your policy by assignment, borrowing does not create income. The trade is a credit decision, the lender's rate and conditions, and repayment from the death benefit if the loan is still outstanding at death. How lenders approach that assignment is on the collateral assignment and the lender.

Interest is deductible only when the rules say so. Borrowing for personal spending gives no deduction on any route. Borrowing to earn income from a business or property may qualify under section 20 of the Income Tax Act. For an insurer policy loan, eligible use alone is not enough: subsection 20(2.1) also requires the insurer's verification, in the prescribed form (T2210), of interest paid in the year that has not been added to the adjusted cost basis. If you deduct the interest, letting it be added to the loan can itself count as a new policy loan and create taxable income once the basis is used up, so ask your accountant whether to pay it in cash. An example of how that plays out for a rental property is on interest on a policy loan used for a rental, and your accountant should confirm it on your own facts.

A corporation changes the questions. When a corporation owns the policy, the loan, the adjusted cost basis and what happens to the death benefit all interact with corporate tax rules, and a loan from the corporation's policy to a shareholder is a different transaction again. Start with the shareholder loan and the policy loan and settle the plan with your accountant before any money moves. None of this is tax advice; your own position belongs with a tax professional working from the insurer's figures.

What does a loan do to the policy itself?

A home equity line leaves your life insurance untouched. A policy loan does not, and four effects are worth knowing before you borrow.

The death benefit shrinks by the balance. Whatever is outstanding at death, loan and unpaid interest, is deducted from the death benefit before your beneficiary is paid. Illustrative example: on an assumed $250,000 death benefit with the $36,751 balance from the earlier example, your family would receive about $213,249. On that assumed, otherwise unchanged death benefit, paying the outstanding loan would remove that deduction; it would not reverse a surrender, a coverage reduction or any dividends affected under the policy.

The dividends may change. As set out above, ask your own insurer in writing; do not build a plan on an assumption.

The protection is measured net of the loan. If a member insurer fails, Assuris protects the higher of $1,000,000 or 90% of the death benefit, and the higher of $100,000 or 90% of the cash value, calculated net of policy loans (Assuris, whole life). Assuris is funded by the industry; it is not a government guarantee, and CDIC deposit insurance does not cover insurance policies. The guarantees in your policy are the insurer's obligations, and they depend on its solvency.

Your beneficiary may have a say. In Quebec, article 2449 of the Civil Code of Québec makes the designation of a married or civil union spouse as beneficiary irrevocable unless the designation says otherwise; that is a Quebec rule, not a nationwide one. An irrevocable designation, in any province, can limit what you may do with the policy without the beneficiary's consent, including borrowing against it or assigning it. Have the insurer check the designation and any required consent before you request a loan, and see the Civil Code and the life insurance contract for how the Quebec rules work.

How can a policy loan go wrong?

The distinctive risk is that unpaid interest can exhaust the value supporting the loan and end the coverage, possibly with a tax bill. Do not assume the insurer's remedies or notices: obtain your contract's loan and lapse clauses.

The sequence is slow. Interest accrues and, if unpaid, may be added to the loan when the contract specifies, so the balance grows a little faster every year. The cash value grows too, and for a long time it may grow faster, but whether it keeps doing so depends on dividends that are not guaranteed and on a loan rate the insurer can change. When the total debt exceeds the cash value, the policy can lapse.

Do not count on a warning arriving in time. Read your annual statement, compare the loan balance with the maximum you could borrow, and ask the insurer for a projection of the balance whenever the gap narrows. Reducing your coverage usually reduces the cash value as well, so it can lower the amount you may borrow rather than solve the problem.

If the balance does come close to the limit, the choices are to repay part of the loan, pay interest in cash, pay more premium, or let the policy end. Every one of them is easier two years earlier than two months earlier.

The tax result of a lapse is the part people miss. A surrender, or a lapse that is not reinstated within the period the Act allows, with a loan outstanding is a disposition too (subsections 148(1) and 148(9)), and it can create a taxable policy gain in a year when no cash is received and none is left to pay the tax. This comes on top of any tax already triggered when the loan was taken above the adjusted cost basis. What happens after a lapse is set out on what happens if the policy lapses.

What should you ask before you choose?

Good decisions here come from documents, not from impressions. These questions turn each route into figures you can compare, and every answer should come to you in writing.

Ask your insurer:

1. What is my current cash value, the maximum I can borrow, and any loan already outstanding with its interest?
2. What is the loan rate today, how is it set, and how and when can you change it?
3. When is interest charged, when is unpaid interest added to the loan, and is there a minimum repayment or a fee?
4. How would a loan affect the dividends on my policy, and can that change?
5. What is my adjusted cost basis today, and how much of the loan I am considering would be taxable?
6. What do you need from me (form, signatures, consents), and how long does a complete request take to pay?
7. Does any assignment, irrevocable beneficiary or premium offset arrangement on my policy limit a loan?
8. At what balance would my policy be at risk of lapse, and what notice would I receive?

Ask any lender you are comparing:

1. What rate would you offer me, in writing, and is it fixed or tied to your prime rate?
2. What security do you require, and what fees apply to set it up and to close it?
3. What is the minimum payment, and can you reduce or call the line?
4. For a collateral loan: what share of the cash value will you lend against, and what happens if the value or your rate changes?

Put the answers in two columns and the comparison mostly makes itself. If the answers are hard to get, that is information too. More on minimums and timing is on how long an advance takes, and whether there is a minimum.

Who does this suit, and who does it not?

A policy loan tends to suit you if you already own a specially designed, high-cash-value, participating whole life insurance policy that has been in force long enough to hold meaningful cash value, you repay what you borrow without being made to, and you value borrowing that does not depend on a lender's opinion of you that year. It can also suit you if your income is irregular or hard to document, so that a credit decision, not the rate, is what stands in your way.

It is not the right tool if the rate is the only thing that matters to you and you already hold a cheaper line; if you need money in the early years of a policy; if you need more than the cash value can support; or if you would not repay without a schedule. It does not suit someone already under financial strain either, because a loan does not create income. It moves money forward in time and adds interest.

A specially designed, high-cash-value, participating whole life insurance policy is life insurance, bought first for its death benefit and its guaranteed values. The loan provision is one feature of it, useful in the right hands and costly in the wrong ones.

The decision stays with you

Which route you should take depends on facts only you can gather: the rate each lender would offer you, the facilities you already have, whether a credit decision would go your way, how much value your policy holds, the tax on each route, and how reliably you repay. With those in hand, the choice is usually clear. Without them, any ranking would be a guess.

What each route is (who lends, what secures it, what can change, how it is taxed) is written in documents you can read before you need the money.

If you already own a policy, Canadian Wealth Creation Centre Inc., the firm that publishes this educational website, can go through the loan options your contract allows, using the insurer's own figures. If you do not own one, the conversation starts with what coverage you need and can afford, never with a loan. The firm serves Quebec, Ontario, Alberta, British Columbia, Manitoba and New Brunswick.

Participating whole life insurance is an insurance product, not an investment. The approach that some people build on its loan provision is the one Nelson Nash called The Infinite Banking Concept®, a registered trademark of Infinite Banking Concepts, LLC; neither this practice nor its author is affiliated with, sponsored by or endorsed by that company or the Nelson Nash Institute. Everything here is written by someone paid by commission from the insurer when a policy is issued, as stated on the author page and at the foot of every page.