Policy loan worksheet: interest, repayments and what the policy can carry

A policy loan feels simple until the first anniversary statement arrives with a larger balance than the one you borrowed. This worksheet turns the loan into six short calculations you can repeat with your own numbers: how fast the balance grows if you pay nothing, what different repayment plans cost, how much of the policy's cash value the loan has used up, and roughly when a lapse becomes possible. Every figure in the worked example is an invented illustration, not a price or a prediction for any policy.

What you need before you start

Gather four facts from the most recent annual statement or from a call to the insurer. If a number is not on the statement, ask for it in writing.

• Current loan balance, including interest already added to it. Call it L.
• Loan interest rate in the contract, written as a decimal (6% is 0.06). Call it r. Check whether it is fixed or variable, and whether interest is charged once a year, on each anniversary, or more often. This worksheet assumes annual compounding, which is the simplest case. If your contract compounds more often, the balance grows a little faster than the worksheet shows.
• Cash surrender value (the cash value less any surrender charge), as of today. Call it C. The cash surrender value is what the insurer would pay if the policy ended, and it is the number the loan is secured by.
• Death benefit in force. Call it D.

You also need one assumption about the future: how quickly the cash value is likely to grow while it is borrowed against. Use the in-force figures from an how to request and read an in-force illustration, and run the worksheet twice, once with the illustrated growth and once with a lower number, because illustrated growth is not guaranteed. Our example uses 3% a year, a round number chosen for simplicity.

For background on what a loan is and how it is taxed, read life insurance policy loans: how they work and what they risk first. The policy loan calculator on this site automates part of what follows, but doing it by hand once shows you where the numbers come from.

The example household

Say Marcus, a hypothetical policyholder, owns a whole life policy with a $150,000 death benefit. His cash surrender value is $48,000. He has borrowed $20,000 at a fixed 6% and has not decided how, or whether, to repay it. These figures are invented for illustration.

Step 1: Grow the balance if you pay nothing

When the interest is not paid, the insurer adds it to the loan on each anniversary. The next year's interest is then charged on the larger balance. The formula for the balance after n years is:

Balance after n years = L x (1 + r) to the power n

Marcus's year-by-year balance, working it one year at a time so each step can be checked:

1. Year 1: $20,000 x 1.06 = $21,200.00
2. Year 2: $21,200 x 1.06 = $22,472.00
3. Year 3: $22,472 x 1.06 = $23,820.32
4. Year 4: $23,820.32 x 1.06 = $25,249.54
5. Year 5: $25,249.54 x 1.06 = $26,764.51

Ten years of silence turns $20,000 into about $35,817, so $15,817 of the balance is interest on top of what he borrowed. After twenty years the balance is about $64,143, and after thirty about $114,870. That is the compounding effect described in the policy loan and policy loan interest glossary entries: the debt more than triples in thirty years at 6% even though no new money was borrowed.

Your turn. Fill in the blanks and use a calculator or spreadsheet:

• L = $______ r = ______
• Balance after 5 years = L x (1 + r) five times over = $______
• Balance after 10 years = $______
• Balance after 20 years = $______

Step 2: Test three repayment plans

Not paying anything is one choice. Paying only the interest and paying the loan off over a fixed number of years are others. Here are three plans on Marcus's $20,000 loan at 6%, with payments made at the end of each year.

Plan A, pay nothing. The balance after 10 years is $35,816.95. Cash out of pocket: $0. Interest accrued and unpaid: $15,816.95.

Plan B, pay the interest each year. Interest is $20,000 x 0.06 = $1,200. If he pays exactly $1,200 each year the balance stays at $20,000 for as long as he keeps doing so. Over 10 years he pays $12,000 and still owes $20,000. This plan stops the growth but does not reduce the debt.

Plan C, pay a fixed amount that clears the loan in a set number of years. The standard loan formula gives the yearly payment:

Payment = L x r / (1 - (1 + r) to the power -n)

For 10 years, Marcus's payment is about $2,717.36 a year, or $27,173.60 in total, of which $7,173.60 is interest. For 5 years it is about $4,747.93 a year, or $23,739.64 in total, of which $3,739.64 is interest. Shorter plans cost more per year and less in total interest.

A partial plan sits between them. If Marcus pays $2,000 a year, more than the $1,200 of interest, the balance falls slowly:

Check one line: $19,200 x 1.06 = $20,352.00, and $20,352 - $2,000 = $18,352.00. The same check works for every row.

Your turn:

• Interest-only payment = L x r = $______
• Ten-year payoff payment = $______ (use L x r / (1 - (1 + r) to the power -10), or a spreadsheet's payment function)
• A payment you can afford = $______, and the balance after 10 years at that payment = $______

Nothing in a policy loan forces you to pick a plan. That flexibility is the feature, and it is also the trap: with no required payment, the balance quietly follows Plan A unless you decide otherwise.

Step 3: Measure what the loan has used of the cash value

The loan is secured by the policy's value, so the figure that matters for survival is the share of the cash surrender value already claimed:

Loan-to-value = loan balance / cash surrender value

Marcus starts at $20,000 / $48,000 = 41.7%. Now put both sides of the picture together, assuming his cash value grows 3% a year and he pays no loan interest (Plan A). Cash value after n years is $48,000 x 1.03 to the power n.

In year 31 the loan is larger than the cash value. In a policy that has to be funded from its own cash value, that is the point where the policy can no longer pay its way and a lapse notice follows. The tax consequence of that moment is the subject of a lapse with an outstanding loan, worked through to the tax bill.

The example is deliberately gentle. It assumes Marcus keeps paying every premium out of pocket and that the cash value keeps growing at 3%. If the policy is a universal life contract whose monthly charges are deducted from cash value, growth can be slower or even negative in later years, and the crossing point arrives sooner. The insurer's projection in an how to request and read an in-force illustration shows this directly; ask for one at your current loan balance.

Your turn:

• Loan-to-value today = L / C = ______%
• Cash value in 10 years at your assumed growth = $______; loan balance at your chosen plan = $______; ratio = ______%
• Year in which the ratio reaches 100% under Plan A = ______ (extend the table until it crosses)

Many insurers send a warning notice well before the ratio reaches 100%, and some policies have an overloan protection riders: how they prevent a taxable lapse that acts at a stated percentage. Do not wait for a letter. A ratio rising past roughly 75% in the worksheet is a signal to change the plan.

Step 4: See what is left of the death benefit

An unpaid loan comes out of the death benefit when the insured dies. The formula is plain:

Benefit paid = death benefit - loan balance (with accrued interest)

For Marcus under Plan A:

By year 30, the loan has consumed more than three-quarters of the death benefit. That may suit a household that wanted the cash and always planned to leave a smaller benefit. It may be a shock to the family that was counting on $150,000. The beneficiary receives the net amount, generally free of income tax when the policy is not a modified endowment contract and stays in force, but not the original face amount.

Your turn: Death benefit D = $______; minus the balance in the year you may die or the year you want to plan for = $______.

Step 5: Check the tax edge

The worksheet so far shows the cash side. One more calculation shows the tax side, because a lapse with a loan outstanding is treated as though you received the loan.

Possible taxable gain at lapse = loan balance extinguished + any cash paid out - cost basis

Marcus's basis (the premiums he has paid, less any tax-free amounts he has already taken) is a figure you can find on the annual statement or by asking the insurer; the glossary entry on cost basis explains it. Say it is $36,000. Suppose the policy ends in year 31 with the loan and the cash value both at roughly $120,000. The loan that disappears counts as money received, so the rough gain is $120,000 - $36,000 = $84,000. That would be ordinary income, with no check arriving to pay the bill. The exact figure depends on details such as the surrender value on the date the policy ends, so the point of this step is not to compute a tax bill; it is to see that the gap exists. Details are in how cash value is taxed: withdrawals, loans and surrenders, and a tax professional should confirm the actual figures.

Your turn:

• Basis = $______ (from the insurer)
• Loan balance at the year you tested = $______
• Rough gap = loan balance - basis = $______ (if positive and the policy lapsed, this is the order of magnitude of taxable income)

Step 6: Choose a plan and set a review date

With the five results in hand, write down which of these outcomes your numbers support.

1. Loan-to-value stays under about 50% for the foreseeable future. You have room. Set a yearly check.
2. The ratio rises steadily toward 75% or more. Raise your yearly payment, at least to the interest-only level, and rerun Step 3.
3. The ratio reaches 100% within your life expectancy. The policy as structured cannot carry this loan. Options include paying down principal, adding premium, reducing the death benefit, asking whether a protection rider applies, or planning the exit with a tax professional before the lapse chooses the timing for you.
4. The death benefit net of the loan no longer meets the reason you own the policy. Reconsider the loan, or the policy.

A policy loan does not have a deadline, so the worksheet's job is to make a gradual process visible. Put a calendar reminder at each policy anniversary: request the loan balance, rerun Steps 1 to 4 with the new figures, and compare against last year.

A second pass: changing course at year 10

The value of the worksheet is that it lets you test a change before you make it. Say Marcus ignores the loan for ten years, then reads his statement and sees the balance at $35,816.95. He reruns the steps and decides to start paying $4,000 a year at each anniversary.

Year 11 works like this. Interest on the balance is $35,816.95 x 0.06 = $2,149.02. His $4,000 payment covers that interest and leaves $1,850.98 to reduce principal, so the balance after the payment is $35,816.95 + $2,149.02 - $4,000 = $33,965.97. Each later year the interest is a little smaller and more of the payment reaches principal.

Compare year 20 with Plan A, where the balance reached $64,142.71. Under the new plan the loan-to-value at year 20 is $11,419.52 / $86,693.34, about 13.2%, instead of 74.0%. The death benefit net of the loan would be $150,000 - $11,419.52 = $138,580.48. The price was $4,000 x 10 = $40,000 out of pocket. Whether that is worth it is Marcus's decision, and a different household might reasonably choose the lower payment, a smaller death benefit, or paying off the loan from a windfall. The worksheet only makes the trade-off visible.

Questions to put to the insurer after you finish

Once the numbers are on paper, a short call or secure message can confirm the inputs. Ask:

1. What is my exact loan balance today, and what interest is due on the next anniversary?
2. Is my loan rate fixed or variable, and what is the maximum it can reach under the contract?
3. How does the company treat the borrowed portion when it sets dividends or credits interest?
4. At what loan-to-value ratio will you send a warning, and at what point will the policy terminate?
5. If I send a payment, how do I mark it so it goes to the loan principal and not to the next premium?

The fifth question catches a common error. A check without instructions may be applied to a premium, to loan interest, or to principal, depending on the company's rules, and the three have different effects on your balance.

Where this worksheet can mislead you

• Fixed versus variable rates. The example holds r constant. A variable loan rate can rise, which makes Plan A grow faster than the table shows. See fixed, variable and wash loans compared: what borrowing costs net for how rate structures differ.
• Cash value growth. A 3% assumption is arbitrary. A policy whose credited rate on loaned values differs from the rate on unloaned values, or whose dividends change when you borrow, grows differently. direct and non-direct recognition loans: how borrowing affects dividends explains that mechanism.
• Premiums due. The example treats premiums as paid from your pocket. If the policy takes premiums or charges from cash value, add them to the model.
• Several loans. If you took more than one loan at different rates, run Step 1 for each and add them.
• Taxes. The basis step is a rough warning light. Only the policy's own records and a tax professional can say what a lapse would cost.

Key takeaways

• An unpaid policy loan grows by (1 + r) each year: $20,000 at 6% becomes about $35,817 in 10 years and about $64,143 in 20.
• Interest-only payments freeze the balance but do not reduce it; a fixed payoff plan on that loan costs about $2,717 a year over 10 years.
• The key warning figure is loan-to-value, the loan divided by cash surrender value. Watch the trend, not just today's number.
• The loan reduces the death benefit dollar for dollar, and a lapse with a loan outstanding can create taxable income with no cash to pay it.
• Rerun the worksheet every anniversary with a fresh statement and a lower growth assumption as a stress test.