Life Insurance✓ Verified · outline & fact-checked · Sep 2026Difficulty 2/5
A policyowner borrows the maximum amount available from the cash value of a whole life policy. Which consequence is correct?
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Answer & full 3-part explanation (select an option above, or peek)
Why A is correct
A policy loan uses the cash value as collateral. The policy stays in force as long as the loan does not exceed the cash value and interest is maintained. The outstanding loan amount plus accrued interest is deducted from the death benefit when the insured dies, or from the cash value if the policy is surrendered. If the loan plus interest equals the full cash value, the policy may lapse. Policy loans are not taxable income because they are borrowed money rather than a distribution of gain under IRC Section 72.
Why the other options are wrong
- B) The policy does not terminate just because a loan is taken; it remains in force while the loan is within the cash value and interest is paid. If the loan plus interest ever equals the cash value, the coverage may lapse, but that is not immediate termination.
- C) Policy loans are not taxable; borrowing against cash value is not treated as a withdrawal of taxable gain for tax purposes. Because a loan is borrowed money rather than a distribution, no taxable event occurs when it is taken.
- D) The death benefit remains payable but is reduced by the outstanding loan balance; the insurer is not excused from paying the claim. The insurer pays the claim, and the loan is simply deducted from what is delivered.
Memory hook
Borrow from your own vault: coverage lives on, death benefit pays back the vault.