How are the cash value and death benefit of a life insurance policy impacted by loans taken against it?

When a policyholder takes a loan against the cash value of a life insurance policy, the financial dynamics of the policy are affected. Specifically, the cash value and death benefit are both reduced by the amount of the outstanding loan until it is repaid.

This reduction occurs because the loan represents an encumbrance on the cash value that the insurance company recognizes when determining the death benefit. In the event of the policyholder's death, the amount of the loan is deducted from the total death benefit payable to the beneficiaries. Therefore, if the loan is not repaid, the death benefit received by the beneficiaries will be lessened by the loan amount.

Understanding this concept is crucial for policyholders considering taking out a loan against their life insurance, as it directly impacts the total value that their beneficiaries will receive upon their death, as well as the accessibility of the cash value during their lifetime.